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

DBRS Ratings GmbH (DBRS Morningstar) confirmed the Autonomous Community of Catalonia (Catalonia)’s Long-Term Foreign and Local Currency – Issuer Ratings at BBB (low). At the same time, DBRS Morningstar confirmed the Catalonia’s Short-Term Foreign and Local Currency – Issuer Ratings at R-2 (low). The trend on all ratings is 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 significantly reduces 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 trends reflect 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 remaining 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 takes the view that the region will bring back its deficit to a moderate level from 2023, in line with its 2016-21 results. Additionally, DBRS Morningstar views positively the likely return in force of the Budget Stability Law (BSL) in 2024, which should keep encouraging the region to balance its budget.

RATING DRIVERS
The ratings could be upgraded if one or a combination of the following occur: (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 one or a combination of the following occur: (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

Lower Extraordinary Transfers in 2022 Contributed to the Deterioration of Fiscal Performance but Deficit Should Reduce From 2023

In 2022, the budgetary performance deteriorated resulting in a national accounting standards' financing deficit estimated at 1.5% of GDP according to the General State Comptroller (IGAE), from a deficit of 0.4% of GDP in 2021. The deterioration stemmed mainly from lower revenues and increased capital investments. There was a contraction of operating expenditures but the decrease in operating revenues as a consequence of lower COVID-19 related extraordinary transfers received from the central government, resulted in the region widening its operating deficit to EUR 1,968 million in 2022 from EUR 1,354 million in 2021. The capital expenditure net of capital revenues increased to EUR 1,885 million from EUR 493 million in 2021, increasing the financing deficit to EUR 3,845 million (EUR 1,841 million in 2021).

DBRS Morningstar takes the view that some exceptional factors affected the 2022 fiscal performance but that structurally the financial performance has not deteriorated. Additionally the likely return of full capabilities of the BSL from 2024 would further strengthen the fiscal management after the lift of the general escape clause at the EU level. For 2023 DBRS Morningstar expects an increase in revenues based on positive effects of the national financing system and from moderate economic performance. The National Independent Authority for Fiscal Responsibility (AIREF) has estimated in its "Report on Initial 2023 budget" for Catalonia a deficit at 0.5% of GDP this year, which is higher than Catalonia's expectation on the budget at 0.3% of GDP.

However fiscal challenges will remain significant in 2023, with the implementation of transformative reforms underpinned by EU funds. Nonetheless, the related projected investments are under current tight expenditure pressure as a result of higher and longer-than-expected inflationary momentum. Moreover, the recent financial and health crises, coupled with the effects of the conflict in Ukraine, have caused debt increases and the deficit has grown. On the other hand, the energy price shock seems to have eased and generally higher interest expenditures will have a moderate immediate impact, provided that the prudential debt management exercised at the regional government level remains (please see: Spanish Autonomous Communities' Access to State Funding Mechanisms Reduces Interest and Refinancing Risks, https://www.dbrsmorningstar.com/research/412232).

Snap Elections Could Potentially Challenge the Continuation of Strengthening Relationship with the Central Government

Since Summer 2021, DBRS Morningstar considers that the dialogue between both governments has further strengthened with the resumption of political and more technical bilateral discussions, though this could be challenged under the formation of a new government at national level stemming from the general snap elections that are called for July 2023. The relationship between the two governments, that serve as the link for the effectiveness of the institutional framework, has improved in recent years but remains a key rating factor to be monitored. Currently, the degree of financial cooperation between Catalonia and the national government is viewed as relatively strong, despite the fact that it remains affected by longer-term political uncertainty in the region.

DBRS Morningstar acknowledges that the pro-independence stance has become somewhat less confrontational over the last three years, with some diffusion of political tensions. While the independence question will remain over the long-term and potential political tensions could re-emerge following the snap general election, DBRS Morningstar takes the view that the economic and financial institutional relationship between these tiers of government will not deteriorate significantly. The political environment continues to weigh on DBRS Morningstar’s assessment of the overall relationship between the region and the national government compared with its national peers but to a lesser extent than in the past. DBRS Morningstar will continue to monitor the political landscape in Catalonia, particularly the dynamic across political parties in the Catalan and National parliament, to evaluate for any impact on its assessment of the political environment in the region.

The Economic Recovery Is Under Way in Line with the Sovereign but Uncertainties Remain Given Remaining Inflationary Pressures and Increased Financing Costs

For 2022, Catalonia's GDP grew by 5.5%, slightly higher than Spain's overall growth rate of 5.2%, and, in the first quarter of 2023 the region surpassed its pre-pandemic GDP level. For 2023, AIREF’s expectation is more optimistic than the region’s at 2.5% whilst the region used a growth assumption of 1.7% in its budget estimations. During 2022, the services sector was driving growth whilst the industry sector was moderately weighing on growth as a result of the rapid increase in energy prices and the bottlenecks in world trade supply. However, at the beginning of 2023, there are signs of better performance of the industrial sector and the services sector continues to grow albeit at a more moderate pace than in 2022. So far, 2023 industrial performance is driven by a recovery in motor vehicles and transport equipment coupled with a resilient growth in the pharmaceutical industry. DBRS Morningstar therefore takes the view that long-term risks related to coronavirus 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 9.9% and still far below the national average of 12.9%.

The regional economy is expected to continue to recover this year, broadly in line with the national average. DBRS Morningstar expects a continuation of strong tourism performance and robust job market performance to support Spain's GDP, but remaining inflationary pressures, increasing financing costs, and a weaker external backdrop are likely to somewhat weigh on growth in 2023. The European Commission (EC) revised its growth projections for Spain upwards to 1.9% in 2023 and forecast 2.0% growth in 2024 in its Spring 2023 economic forecast, from previously 1.4% for 2023. 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 2.7 billion up to 2022 and EUR 2.1 billion is already utilised, and for 2023 there are budgeted revenues up to EUR 1.2 billion. 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.

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

Despite the higher 2022 deficit, the debt stock is growing at just a moderate pace during the last five years. DBRS Morningstar’s adjusted debt for Catalonia represented EUR 86.6 billion at the end of 2022, moderately increasing from EUR 81.1 billion at the end of 2017. Debt-to-operating revenue decreased markedly over the same period, from 296% in 2017 to 251% in 2022, reflecting stronger revenue growth. Nonetheless, in 2022 this metric deteriorated, from 233% in 2021, but it was mainly caused by the decrease of 2022 revenues.

At the end of 2022, most of Catalonia's debt is at fixed interest rates, amounting to 98% of debt stock, which gives some relief given the current context of rising interest rates. However, the region's relatively short weighted average maturity of its debt stock, standing at 4.9 years at the end of 2022, is likely to translate into higher interest rates after refinancing. However, the access to state financing mechanisms are mitigating this condition, Catalonia has largely benefited from the financing support to the extent that it represented 84% of total regional debt or EUR 71.3 billion. While this support was originally designed to be exceptional, largely to support the Spanish regions’ liquidity, DBRS Morningstar now views it as an ongoing critical credit feature when assessing regional governments’ creditworthiness, and expects Catalonia's financing needs to continue to benefit from the national government's support.

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 (May 17, 2022) 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 Scorecard generates a result in the BBB (high) – BBB (low) range. The main points discussed during the Rating Committee included the potential repercussion of the general snap elections on the relationship with the central government, economic growth prospects and the impact of the inflationary environment, Madrid’s public finances, the region’s debt and liquidity profile, the likelihood of support from the national government, if ever needed.

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/415602.

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 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 in its consideration of ESG factors.

The credit rating methodologies used in the analysis of this transaction can be found at: https://www.dbrsmorningstar.com/about/methodologies.

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, Bank of Spain for the debt stock during the period between 2016 and 2022, Independent Authority for Fiscal Responsibility (AIReF) for its January 2023 monitoring of the 2022 budget stability targets and for its April 2022 report on Catalonia’s Initial budget considerations, Instituto Nacional de Estatística (INE), Ministry of Finance, General State Comptroller (IGAE) and the Spring 2023 economic forecast 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. For further information on DBRS Morningstar historical default rates published by the Financial Conduct Authority (FCA) in a central repository, see https://data.fca.org.uk/#/ceres/craStats.

The sensitivity analysis of the relevant key rating assumptions can be found at: https://www.dbrsmorningstar.com/research/415980.

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: February 24, 2023

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