- In our view, Spain’s commitment to the ongoing implementation of a comprehensive fiscal and structural reform agenda remains strong.
- We are therefore affirming our long – and short -term sovereign credit ratings on Spain at ‘BBB+/A-2’.
- The outlook on the long-term rating is negative, reflecting our view of the multiple risks to Spain’s economic rebalancing, the potential for the crystallization of additional contingent liabilities, and the effectiveness of the eurozone policies in stabilizing funding markets.
- Our current net general government debt projections reflect our assumption that official loans to distressed Spanish financial institutions will eventually be mutualized among all eurozone governments, and thus Spanish net general government debt would remain below 80% of GDP beyond 2015.
On Aug. 1, 2012, Standard & Poor’s Ratings Services affirmed its long- and short-term sovereign credit ratings on the Kingdom of Spain at ‘BBB+/A-2’. The outlook on the long-term rating remains negative.
Our transfer and convertibility (T&C) assessment for Spain, as for all European Economic and Monetary Union (EMU or eurozone) members, is ‘AAA’, reflecting our view that the likelihood of the European Central Bank (ECB) restricting non-sovereign access to foreign currency needed for debt service of non-euro obligations is extremely low.
External auditors are currently assessing the capital needs of Spain’s banking system. We will analyze the outcome of the audit, expected to be completed by the end of September, before assessing the precise cost of the recapitalization. Our current rating is premised on the assumption that the government will not provide any additional direct support to the commercial banking sector beyond the maximum EUR100 billion to be made available initially from the European Financial Stability Facility (EFSF), and subsequently from the European Stability Mechanism (ESM). Our expectation is that the actual cost to the government of providing capital support to distressed Spanish banks will be significantly lower than the current EUR100 billion estimate, given the government’s commitment to minimizing the burden on Spanish taxpayers of bank restructuring. It is our understanding that this will be achieved via loss absorption of equity and hybrid capital instruments as well as burden sharing from subordinated debt holders. Our current net general government debt projections also reflect our assumption that official loans to distressed Spanish financial institutions will eventually be mutualized among all eurozone governments, and thus Spanish net general government debt would remain below 80% of GDP beyond 2015.
Our ‘BBB+’ long-term foreign currency rating on Spain is supported by our view of its diversified prosperous economy, stable political system, and the ongoing implementation of a comprehensive fiscal and structural reform agenda. The rating is constrained by our view of the high external leverage in Spain’s financial sector, significant contingent liabilities, and remaining inflexibilities in the economy, including its still highly segmented labor market.
The Spanish economy is adjusting rapidly away from internal towards external demand, as demonstrated by the strong performance of its exports of goods and services since 2010. On a twelve month rolling basis, Spanish exports of goods and services at end-April 2012 were at record highs, supporting the rapid narrowing of Spain’s current account deficit from 9.7% of GDP in 2007 to an anticipated 2.0% of GDP for 2012. To the extent that external demand holds up, the pace of export performance should continue.
However, one of the secondary consequences of this faster-than-anticipated reorientation of the economy has been a decline in tax receipts, particularly indirect receipts, with the result that the Spanish government’s fiscal deficits have consistently exceeded our forecasts, leading to public debt levels also exceeding our previous projections. During 2012, the pace of deleveraging has actually accelerated, and is likely to lead to an even higher contraction of investment and consumption in both the public and private sectors. This protracted demand weakness could continue to put at risk the ambitious 6.3% of GDP 2012 fiscal target (versus 8.9% of GDP in 2011), by weighing on indirect tax collection in particular.
To help ensure that the 2012 budgetary target is met, on July 13 the Spanish government presented more detailed consolidation measures in addition to those announced in April of this year. The new measures include a hike in the VAT rate from 18% to 21%; increases in corporate and personal income tax rates, plus rises in excise duties; additional cuts to the public sector wage bill; and an agreement to frontload pension payment adjustments.
In July, the central government also established a new regional liquidity mechanism (Fondo de Liquidez Autonomico or FLA) totaling EUR18 billion or 1.7% of projected Spanish GDP. We understand that the largest part of the EUR18 billion will come from a consortium of domestic commercial banks plus a EUR6 billion loan from the state lottery system. Given the high redemptions that many Spanish regional governments are facing next year, the FLA is also expected to require funding lines for 2013. Because Standard & Poor’s already includes the debt of the Spanish Autonomous Communities in the general government debt stock, Spain’s sovereign credit metrics do not change as a consequence of regional government debt being rolled over via the FLA. The ratings would, however, be influenced by any large and persistent budgetary deviations by the Regions relative to their consolidation targets, as these deviations would increase net general government debt.
Our baseline scenario is that during this period of intense reductions in private and public sector net borrowing, Spain will continue to receive support, including financial, from its European partners and the ECB. In our view, this should contribute to the government’s efforts to restore confidence in the financial sector and lay the foundation for a sustainable recovery. While we expect the general government deficit to narrow substantially during 2012, we project the general government deficit will slightly overshoot the target of 6.3% of GDP for 2012; we project this deficit will only drop below 4% of GDP by 2015. However, there is a risk that we may see greater slippage during 2012 and 2013, despite the introduction this year of additional tightening measures including the comprehensive reform of the fiscal framework for Spain’s autonomous regions.
According to public statements, the ESM will eventually replace the EFSF as the source of new capital for problem banks without asserting seniority status. It is unclear whether the ESM will be mandated to take a direct common equity stake in any Spanish commercial bank. Our current net general government debt projections reflect our assumption that official loans to distressed Spanish financial institutions will eventually be mutualized among all eurozone governments and thus Spanish net general government debt would remain below 80% of GDP beyond 2015.
We continue to view Spain and other eurozone governments receiving official assistance as vulnerable to delays or setbacks in the eurozone’s plans to pool sufficient common resources to support sovereign lending facilities, to create a banking union with a single regulator and a common resolution framework by end 2012, and to move toward closer fiscal integration. We agree with ECB President Mario Draghi who said on July 26 that financial fragmentation within the eurozone is at the heart of the union’s broader economic problems. In our view, if this fragmentation is not reversed, Spain’s economy could contract sharply, unemployment rise even further, social cohesion fray, and reforms stall or reverse.
The negative outlook on our rating on Spain reflects our view of the risks to our baseline scenario from two principal sources:
- The possibility of an even steeper than anticipated GDP contraction, stemming from rapid financial sector deleveraging and weakening external demand, accompanied by further increases in unemployment that undermine the government’s willingness to implement additional reforms. This might occur should there be a delay or a reversal in eurozone fiscal and banking integration.
- Changes to our assumptions regarding the ultimate liability for Spain’s banking sector. In this regard, we note that Spanish financial sector commercial foreign debt (which is equal to the banks’ foreign debt excluding the liabilities of the Banco de Espana to the eurosystem), which as of end first-quarter 2012, totaled EUR656 billion or 61% of Spanish GDP, is considerably greater than the EUR230 billion (22% of GDP) stock of government debt owed to nonresidents at end Q1 2012. We note that unofficial data indicates that private nonresident holdings of Spanish government and financial sector debt have fallen considerably during Q2 2012, as capital outflows continue.
Among other metrics, we would then see net general government debt rise to above 80% of GDP during 2012-2014.
We could also lower our ratings on Spain – potentially by as much as a rating category (i.e. below ‘BBB-‘) – if we see that eurozone support fails to engender confidence sufficient to keep government borrowing costs at levels consistent with debt sustainability, and a primary general government budget position in broad balance.
On the other hand, we could revise the outlook on the rating to stable if the government’s budgetary and structural reform measures, coupled with a successful eurozone support program, stabilize Spain’s credit metrics.