DBRS Morningstar Confirms the Autonomous Community of Catalonia at BBB (low), Stable Trend

DBRS Ratings GmbH (DBRS Morningstar) confirmed the Long-Term Issuer Rating of the Autonomous Community of Catalonia (Catalonia) at BBB (low) and the Short-Term Issuer Rating at R-2 (low). The trend on all ratings remains stable.

KEY RATING CONSIDERATIONS

Catalonia's ratings are underpinned by (1) the region’s track record of improving its debt metrics since 2016; (2) the financing support provided by the Kingdom of Spain (A, Stable) to the regional government which reduces significantly refinancing risks; (3) DBRS Morningstar's view that the relationship between the regional government and the national government has slowly but steadily strengthened over the last years. While the independence question will remain a structural topic in the region over the medium-to-long-term and sporadic tensions could re-emerge, DBRS Morningstar takes the view that the economic and financial institutional relationship between these tiers of government will not deteriorate significantly.

The Stable trend reflects DBRS Morningstar's assessment that the risks to Catalonia's ratings are broadly balanced. The economic outlook remains clouded with uncertainties around the impact of inflationary pressures and higher interest rates. Nevertheless, Catalonia's finances have weathered relatively well the economic shock of the Coronavirus Disease (COVID-19) pandemic, supported by the extraordinary financial transfers provided by the national government to all Spanish regions. Despite a deterioration of its fiscal performance in 2022, DBRS Morningstar expects the region to bring back its deficit to a moderate level from 2023, in line with its 2016-2021 results. Additionally, DBRS Morningstar views credit positive the likely return in force of the Budget Stability Law in 2024, which should keep encouraging the region to balance its budget.

RATING DRIVERS

The ratings could be upgraded if: (1) the relationship between the region and the national government strengthens further, with a long-term solution preventing the emergence of political tensions between both government tiers; (2) the region continues its fiscal consolidation towards a balanced budget position and improves its debt sustainability metrics; or (3) the Kingdom of Spain’s rating is upgraded.

The ratings could be downgraded if: (1) there are indications that a material escalation of the political tensions between both government tiers could affect the financing support received by the region; or (2) there is a structural deterioration in the region’s fiscal performance, leading to wider deficit and placing debt metrics on a deteriorating trajectory.

RATING RATIONALE

Following Years of Moderate Deficits, Fiscal Performance Deteriorated in 2022 Despite the High Level of Funding Provided to the Region by the Central Government, but Should Improve Again From 2023

The region has been able to improve its fiscal performance since 2016 and to post only moderate deficits between 2016 and 2021. Nevertheless estimates for 2022 budget execution point to a higher deficit reaching 1.3% of GDP according to the Independent Authority for Fiscal Responsibility (AIReF) versus 0.4% in 2021, using national accounting standards. The deterioration relates to the lower extraordinary pandemic-related transfers received from the central government, despite the partial compensation for the drop of these funds by the 2020 negative settlement compensation and a VAT month payment shortfall from 2017. Catalonia is expected to have underperformed compared to its Spanish peers given that current forecasts from AIReF suggest that autonomous communities have recorded a deficit of 1.1% in 2022. In 2023, AIReF does not anticipate that Catalonia will comply with the reference rate of 0.3% set by the central government, instead forecasting a deficit of 0.5%. Nevertheless, Catalonia expects to comply with the reference rate.

In 2022, the national government has maintained a high level of transfers (entregas a cuenta) to its regions and these transfers were also complemented by extraordinary transfers of EUR 7.5 billion meant to compensate regions for a negative fiscal settlement related to 2020 and a VAT payment shortfall from 2017 received in 2022. While these additional funds continued to support regional finances in 2022, they represent a substantial decrease compared to the extraordinary COVID-19-related transfers received in 2020 and 2021 of EUR 16.0 billion and EUR 13.5 billion, respectively. Accordingly, Catalonia's fiscal performance weakened in 2022 compared to 2020 and 2021. The region’s provisional budget execution for 2022 points to lower revenue as expected but the expenditure control has not been sufficient to compensated for this shortfall. Pandemic-related expenditure dropped to less than half of their 2021 level, but total expenditure grew due to significant increases of capital and current expenditure related to the mechanisms of the recovery and resilience funds along with higher staff expenditure.

For 2023, DBRS Morningstar does not expect any extraordinary transfers from the regional funding system, however, the amount of transfers (entregas a cuenta) for the regional sector-tier will increase by around 24% compared with 2022. This should ensure that autonomous communities receive enough funding to cover their responsibilities, which DBRS Morningstar views positively given the current economic challenges including high inflation. DBRS Morningstar takes the view that expenditure control to maintain a sound budgetary position over the medium-term will also remain critical for regions, including Catalonia.

Fragmented Regional Parliament Triggers Continuation of Strengthening Relationship with Central Government

On the political front, the regional government has been led by Pere Aragonès from Esquerra Republicana de Catalunya (ERC) since May 2021. Pro-independence parties including Junts Per Catalunya and CUP currently maintain a majority in the regional parliament with 74 seats out of 135. Although the independence question remains critical for the current government, DBRS Morningstar considers that the regional rhetoric on this topic has been more oriented towards political dialogue than direct confrontation. This has been confirmed since Summer 2021 with the resumption of bilateral discussions between the region and the national government, either in the form of a purely political "mesa de dialogo", with the last one held in July 2022, or more technical ones, intended to make progress on economic and fiscal arrangements, such as the one that occurred in March 2022 ("Comisión Mixta de Asuntos Económicos y Fiscales Estado-Generalitat").

While the regional government has so far continued to voice its request to organise a formal referendum on independence, finding a short-term solution to this question appears unlikely. Over the medium-term, some political tensions are likely to re-emerge but DBRS Morningstar expects the tone of the political interaction between the regional and the national governments to remain less confrontational. For instance, there have been many signs following bilateral conversations between governments which reached some arrangements that have promoted changes on financial, legal and institutional features of their framework. DBRS Morningstar also notes that the region managing to approve its annual budget for 2023 with Partido Socialista Catalan (PSC) which was not part of the government formed after the elections, could denote further evidence of this. DBRS Morningstar will continue to monitor the political landscape in Catalonia, particularly the dynamic across political parties in the Catalan parliament, to evaluate for any impact on its assessment of the political environment in the region.

The Economic Recovery Is Under Way but Uncertainties Remain Given Inflationary Pressures in Europe

In terms of economic growth, AIREF estimates Catalonia’s 2022 real GDP growth at 5.5%, slightly above the national expectation of 5.3%,. In 2020 Catalonia's gross domestic product (GDP) decreased by 10.9%, marginally worse than Spain's 10.2% decline, largely reflecting the extent of the healthcare crisis, the stringency of the lockdown that followed, and the high concentration of economic activity in sectors severely affected such as tourism as well as the export-oriented feature of the Catalan economy. In 2021, Catalonia's GDP increased slightly faster than the national average, at 8.0% according to provisional estimates by the national Statistics Institute, compared with 7.9% for the national average. The regional economy is expected to have continued to recover this year, broadly in line with the national average. DBRS Morningstar expects a strong tourism performance and solid job creation to support Spain's GDP, but inflationary pressures, particularly higher energy prices, increasing funding costs, and a weaker external backdrop are likely to weigh on growth afterwards. Amid this background, the European Commission (EC) revised its growth projections for Spain upwards to 5.5% in 2022 and to 1.4% in 2023 in its Winter 2022 projections, from previously 4.5% and 1.0% respectively.

DBRS Morningstar therefore takes the view that long-term risks related to COVID-19 have receded, as exemplified by the strong performance of the labour market in recent months. As of 2022, Catalonia's unemployment rate had recovered its pre-pandemic level and reached its lowest level since 2008, close to 9.7% and still far below the national average of 12.9%.

The financial resources expected from the Next Generation EU (NGEU), including the Recovery and Resilience Facility (RRF) and REACT-EU funds, should continue to alleviate the long-term impact of the pandemic and support the recovery. The region estimates revenue received related to these funds at around EUR 2.1 billion in 2022 and EUR 1.6 billion is spent. Going forward, the impact of higher inflation on consumption and investment as well as the speed of absorption of EU funds will remain key areas of focus for DBRS Morningstar to assess the strength of the recovery within the region's territory.

The National Government’s Financing is Critical to the Region’s Creditworthiness

DBRS Morningstar expects Catalonia's financing needs to continue to benefit from the national government's support. Such financing is critical for the region's credit ratings. DBRS Morningstar’s adjusted debt for Catalonia is very high, at close to EUR 86 billion at the end of 2022. This represents around 250% of the region's operating revenues, increasing from 233% in 2021 given the loss of extraordinary transfers from the central government, but below the 277% level recorded in 2019; or around 37% of the region's GDP in 2021 compared with 34% in 2019. DBRS Morningstar gains comfort around the region's debt sustainability given the support it receives from the national government. The Spanish Treasury currently holds more than 80% of Catalonia's debt stock (Banco de España data) and the region has benefited from very low funding costs in recent years. While the healthcare crisis and inflation has been challenging for regional finances, DBRS Morningstar continues to consider that Catalonia remains committed to strengthening its financial performance over the medium-term.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS

Social (S) Factors

The Passed-through Social credit considerations have a relevant effect on the ratings, as the social factors affecting the Kingdom of Spain’s ratings are passed-through to Catalonia.

There were no Environmental or Governance factors that had a significant or relevant effect on the credit analysis.

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/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings.

RATING COMMITTEE SUMMARY

DBRS Morningstar’s European Sub-Sovereign Governments Scorecard generates a result in the BBB (high) – BBB (low) range.

The main points discussed during the Rating Committee include the political environment in the region and its impact on the region’s relationship with the national government, the region’s financial performance including the 2022 execution and its 2023 budget, the financial support received from the national government, the region’s high debt metrics and the medium-term economic and public finances prospects for the region, the region’s economic recovery including its tourism sector.

For more information on the Key Indicators used for the Kingdom of Spain, please see the Sovereign Scorecard Indicators and Building Block Assessments: https://www.dbrsmorningstar.com/research/410073/spain-kingdom-of-scorecard-indicators-and-building-block-assessments

The national scorecard indicators were used for the sovereign rating. The Kingdom of Spain’s rating was an input to the credit analysis of the Autonomous Community of Catalonia.

Notes:
All figures are in euros (EUR) unless otherwise noted.

The principal methodology is the Rating European Sub-Sovereign Governments (August 12, 2022) https://www.dbrsmorningstar.com/research/401273/rating-european-sub-sovereign-governments. In addition DBRS Morningstar uses the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings https://www.dbrsmorningstar.com/research/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings (May 17, 2022) in its consideration of ESG factors..

The sources of information used for this rating include the Autonomous Community of Catalonia for financial position, budgetary execution and debt structure for the 2016-22 period, Catalonia’s Investor Presentation, Bank of Spain for the debt stock during the period between 2016 and 2021, Independent Authority for Fiscal Responsibility (AIReF) for its January 2023 monitoring of the 2022 budget stability targets and for its October 2022 report on Catalonia’s budget considerations, Instituto Nacional de Estatística (INE), Ministry of Finance; the 2020 European Social Progress Index from the European Commission. DBRS Morningstar considers the information available to it for the purposes of providing this rating to be of satisfactory quality.

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.

The conditions that lead to the assignment of a Negative or Positive trend are generally 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: https://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/410292.

This rating is endorsed by DBRS Ratings Limited for use in the United Kingdom

Lead Analyst: Jorge Espinosa, Assistant Vice President, Global Sovereign Ratings
Rating Committee Chair: Thomas R. Torgerson, Managing Director, Co-Head Global Sovereign Ratings
Initial Rating Date: February 1, 2019
Last Rating Date: September 09, 2022

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