Fitch: Spain 2015 Deficit Highlights Structural Fiscal Challenge
Spain's general government deficit fell to 5.1% of GDP (5.0% excluding bank recapitalisation costs) from 5.9% in 2014, but well short of the official target of 4.2% (and our forecast of 4.7%). Regional and social security budgets missed their targets by 1pp and 0.7pp respectively, whereas the central government deficit was 0.3pp within target at 2.6% of GDP as strong GDP growth boosted revenues. Overall, recent general government deficit reduction has been driven by economic recovery and low funding costs, with no improvement in the cyclically adjusted balance.
The 2015 fiscal slippage reinforces our view that Spain's high public debt, at 99% of GDP more than double the 'BBB' category median, will fall only gradually, and that the 2016 deficit will not come close to the 3% of GDP threshold to exit the Excessive Deficit Procedure (EDP). Earlier this week, the government revised up its 2016 budget deficit target from 2.8% of GDP to 3.6%, requiring an extension to the EDP deadline.
The European Commission has highlighted weak enforcement of 2012 Budgetary Stability Law (BSL) powers over regional budgets. A track record of more effective enforcement would be positive for Spain's fiscal credibility. BSL mechanisms such as notifying regions when they should submit adjustment plans, and jointly drafting binding expenditure and liquidity management plans, have been more actively applied recently. Spain's interim government has outlined further measures including a pre-defined process if regional budgets go off-track, with the threat of using BSL powers to withhold funds if adjustment plans are inadequate, and a working group is assessing regional financing reform options.
The BSL's role in improving the regions' aggregate fiscal performance supported our introduction of a 'BBB-' ratings floor for Spanish regions in March 2013 (the floor does not currently apply to Catalonia). However, regional fiscal slippage against central government targets, as seen in 2015, highlights the importance of structural reform of regional funding alongside enforcement.
Preliminary 2015 Ministry of Finance accounts show a negative regional operating balance of EUR6.4bn, up from EUR3.3bn in 2014. Many regions have budgeted for a positive current balance in 2016, but we forecast that the sector will report another overall negative balance. Repeated negative current balances mean that debt repayment must be funded from debt issuance. The availability of debt service mechanisms such as the Regional Liquidity Fund helps offset this risk and is another key support of our regional ratings floor.
Discussions regarding the regions' funding responsibilities in areas such as healthcare, which could address their complaints of underfunding, have resumed, but may be slow due to the political uncertainty following last December's inconclusive general election. Meanwhile, spending cuts could face considerable opposition from regions, and tension may increase as the central government introduces additional conditions for transfers from the Regional Liquidity Fund, which can require reprioritisation of EUR10bn of regional budgets (equivalent to 8% of regional operating expenditure).
More generally, uncertainty over the composition of the next government adds to uncertainty about fiscal consolidation. We do not anticipate significant changes to the 2016 budget by the current interim government, with deficit reduction continuing to be driven by higher revenues from above-trend GDP growth.
We affirmed Spain's 'BBB+'/Stable sovereign rating in late January. High public debt is a key rating weakness.