Fitch Affirms Spain at 'BBB+'; Outlook Stable
KEY RATING DRIVERS
Spain's IDRs balance a strong recovery from its deep recession, current account surplus and robust institutional strength with high government, private sector and external debt ratios, and high unemployment.
The affirmation reflects the following key rating drivers:
Spain is benefitting from a strong recovery with economic growth that is the fastest among larger eurozone members and in line with the 'BBB' median of 3% in 2015. In light of the stronger-than-expected growth since the last rating review in April 2015 Fitch has revised up its GDP forecast to 3.1% in 2015, 2.5% in 2016 and 2.2% in 2017. The recovery is broad-based and is mainly driven by domestic demand. Employment grew 480,000 in January-September 2015 and the unemployment rate declined to 21.2% in 3Q15 from 23.7% in 4Q14.
Fitch views the strong recent growth performance as predominantly a cyclical recovery, while the level of GDP is still 4pp below the pre-crisis peak due to the deep and prolonged recession during 2009-2013. Fitch maintains its estimate of potential growth at around 1.5% over the medium term, though upside risks have increased in light of the current robust growth performance and progress with balance sheet adjustments underpinned by previous structural reform measures.
The stronger-than-expected growth and the very low interest rate environment are having a favourable impact on the budget balance. Fitch forecasts an improvement in the headline budget deficit to 4.3% of GDP in 2015, down from 5.8% in 2014, although this would still be the largest in the eurozone, before declining further to 3.1% in 2016.
However, the improvement is solely cyclical and Fitch does not expect any improvement in the underlying, structural fiscal position between 2014 and 2016. Nevertheless, real-time measures of the output gap and the structural position are inherently uncertain. A larger negative output gap and firmer short-term growth prospects would imply a larger cyclical improvement in the fiscal position in the coming years and less need for further structural adjustment to meet medium-term EU fiscal targets. The outcome of the general elections in December also creates uncertainty over fiscal policy.
Public debt is about to stabilise, albeit at a high level. Fitch forecasts the gross general government debt (GGGD)-to-GDP ratio to peak at 99% in 2015, compared with 36% in 2007 and the 'BBB' median of 40%. The GGGD-to-GDP ratio will decline close to 90% by 2024 according to our baseline scenario.
Favourable financing conditions have prevailed since the previous rating review. The yield on 10-year sovereign bonds was around 2% in 3Q15 and the short-term yield has been close to 0% since February 2015. The average issuing yield during the January-September 2015 period was just 0.9%. The prolonged low yield environment, combined with a 6.5 year average life of GGGD, should lead to a steady declining trend in interest expenditure over the coming years.
Spain has achieved a more than 10pp of GDP adjustment in its current account (CA) position between 2009 and 2013, reflecting not just a compression of imports in the recession but also gains in competitiveness and an increase in exports/GDP. Fitch forecasts the CA surplus to remain at 1%-2% of GDP until 2017, as exports continue to grow strongly while the recovery of domestic demand, and investment in particular, boosts imports.
High external indebtedness - reflecting high public and private debt burdens - and reliance on intra-eurozone capital flows will remain a key vulnerability of the Spanish economy for a prolonged period, despite the return to CA surplus and a low interest rate environment. Net external debt is estimated by Fitch at 89% of GDP in 2015, more than 10x the 'BBB' median of 7%.
The combination of strong recovery, declining unemployment and stabilising house prices has had a positive impact on the banking sector's asset quality, reducing systemic financial stability risks. Spanish banks' asset quality continues to improve, albeit from weak levels. Fitch expects loan growth to resume in 2016, probably in low single digits, as deleveraging pressures ease and a better economic outlook and stronger confidence support credit demand.
Demand for greater autonomy for Catalonia by a significant proportion of the population has increased tensions between the regional and central governments. Although the outcome of the Catalan regional elections in September appears to have reduced the risk of a near-term constitutional crisis, tensions are likely to persist, in Fitch's view. It will be challenging to reach an agreement on regional autonomy that is mutually acceptable to the central government, Catalonia and other Spanish regions.
The following factors may, individually or collectively, result in positive rating action:
- Further progress in shrinking the budget deficit at the general government level, particularly if based on structural measures, leading to a downward trend in public debt/GDP ratio.
- Increased confidence of stronger growth potential, leading to further improvement of the labour market while maintaining a CA surplus.
- Improvement in Spain's external balance sheet.
The following risk factors may, individually or collectively, result in negative rating action:
- Loosening of Spain's fiscal policy stance or a reversal of structural reform measures.
- Lower nominal GDP growth and/or crystallisation of contingent liabilities, leading to public debt/GDP ratio to peak at higher levels and later than forecast.
- Emergence of a large CA deficit.
The fiscal projections used in the ratings review are based on the assumption that the current fiscal policy stance will be broadly maintained by the new government to be formed after the December 2015 general election, in line with the draft 2016 budget. We also assume that future governments will keep public debt/GDP on a declining path in the latter half of the decade, consistent with eurozone and Spanish fiscal rules.
The debt dynamics calculation is based on the assumption of real GDP growth converging to its 1.5% medium term growth potential as the economic slack is gradually absorbed, GDP deflator stabilising at 1.5% by 2019 from its trough of -0.5% in 2014 and a permanent primary surplus of 0.7% of GDP from 2019 onwards.
The European Central Bank's asset purchase programme should help underpin inflation expectations, and supports our base case that in the context of an economic recovery, Spain and the eurozone will avoid prolonged deflation. Nevertheless deflation risks could re-intensify in case of adverse shocks and Spain's competitiveness adjustment within the currency union will continue to exert downward pressure on prices over the medium term. This will make the balance-sheet adjustment of the public and private sectors more challenging.