London, 21 February 2014
Moody’s Investors Service has today upgraded Spain’s government bond rating to Baa2 from Baa3 and assigned a positive outlook. Concurrently, Moody’s has also upgraded Spain’s short-term rating to (P) Prime-2 from (P) Prime-3.
The key drivers for upgrading Spain’s debt ratings and assigning a positive outlook are as follows:
- The rebalancing of the Spanish economy towards a more sustainable growth model, which is being underpinned by structural improvements in the country’s external competitiveness, and the ongoing deleveraging in the domestic economy.
- The progress made in implementing broad structural reforms, particularly in the labour market and the public pension system, structural fiscal measures and changes to the fiscal framework for the country’s regional governments as well as the restructuring of the Spanish banking system. These efforts support Moody’s expectation of stronger, more sustainable economic growth over the medium term and continued improvements in the resilience of government finances.
- The improvement in the government’s funding conditions since the height of the euro area sovereign debt crisis in mid-2012. In Moody’s view, the fall in borrowing costs reflects the combined effects of the European Central Bank’s (ECB) policy announcements and actions, the evident improvements in the Spanish economy, and the government’s track record of implementation of fiscal and structural policy measures.
However, Spain’s creditworthiness remains constrained by low fiscal strength as a result of the government’s still significant budget deficit (7.0% of GDP in 2013), and a high debt-to-GDP ratio (approximately 94% of GDP in 2013) which Moody’s expects to peak only in 2016 at a level of above 102% of GDP. Moreover, the Spanish economy is still confronted with a relatively weak banking system with still deteriorating asset quality and the need to reduce the high levels of private-sector debt. Unemployment will only decline slowly from its current elevated levels.
Concurrently, Moody’s has today also upgraded the ratings of the Fondo de Reestructuración Ordenada Bancaria (FROB) to Baa2/P-2 from Baa3/P-3. The outlook on the ratings is positive. The FROB’s bond issues benefit from an irrevocable and unconditional guarantee from the Government of Spain.
Spain’s local and foreign currency bond and deposit ceilings have been raised to A1 from A3 to reflect improvements in institutional strength and reduced susceptibility to event risk, associated with lower government liquidity and banking sector risks. Spain’s short-term foreign-currency debt and deposit ceilings are Prime-1.
RATIONALE FOR UPGRADE
— FASTER-THAN-EXPECTED PROGRESS IN REBALANCING OF THE ECONOMY
The first driver of Moody’s decision to upgrade Spain’s rating to Baa2 are the country’s improving medium-term economic prospects, underpinned by a rebalancing of the economy away from real-estate investment towards exports, which should provide for a more sustainable growth trajectory. Not only has the Spanish economy started to grow again in Q3 2013, the growth pattern is also becoming more balanced. Business investment has started to contribute positively and consumer confidence has been improving on the back of an earlier-than-expected stabilisation in the labour market. At the same time, both the corporate and household sectors continue to reduce their high debt burdens. Financial conditions for the private sector have also improved in recent months. Moreover, competitiveness gains have been substantial and will continue to underpin the export sector as wage growth will likely remain very moderate in the coming years. Exports are also significantly more diversified than before the crisis, limiting the vulnerability to a growth slowdown in any one region. Overall, the rebalancing of the economy has proceeded faster than Moody’s had previously expected.
Improving economic prospects in turn provide a greater level of confidence that Spain’s still elevated budget deficit can be gradually reduced over the coming years. The 2013 general government budget deficit target of 6.5% of GDP (excluding bank restructuring cost of 0.5% of GDP) is likely to have been reached, and Moody’s also considers this year’s target of a deficit of 5.8% of GDP to be achievable. However, Moody’s expects the public debt ratio will continue to increase for several more years given the persistent budget deficits and relatively moderate nominal GDP growth, before peaking at above 102% of GDP in 2016. Moody’s also expects the unemployment rate to decline only slowly over the coming years, although the labour market reforms have probably lowered the rate of GDP growth necessary to achieve significant net employment creation.
— BROAD STRUCTURAL REFORMS IMPROVE MEDIUM-TERM GROWTH OUTLOOK
Spain’s improving medium-term growth and fiscal outlook are supported by wide-ranging structural reforms and changes in taxation and spending programs. Overall, these reforms give greater confidence that the Spanish economy can indeed return to a path of sustained positive economic growth. Most important of these have been reforms to the labour market that support wage moderation and a strengthening of external competitiveness. Additional measures include the implementation of structural fiscal measures to reduce the fiscal deficit on a sustainable basis as well as material changes to the fiscal framework at the regional government level. Moreover, measures to reduce the size of the public sector are ongoing. The government will soon present the outline for a tax reform to be implemented in 2015, which aims to reduce the heavy tax burden on labour in favour of higher taxes on capital, consumption and higher environmental charges.
In addition, the public pension system is being thoroughly reformed, which will improve the long-term sustainability of Spain’s public finances. In particular, the latest reforms in mid-2013 introduced the financial balance of the social security system as an adjustment factor for pensions, which should effectively limit the risks to the public finances arising from the ageing of the population. In addition, the de-indexation of pensions from consumer price inflation brings fiscal savings already in 2014 as pensions rise by only 0.25% compared to annual increases of around 4% per annum in previous years. Finally, the banking sector has undergone a deep restructuring, and bank-related contingent liabilities pose far less of a threat to the government finances than even a year ago.
— REDUCED RISK OF A SUDDEN STOP AND LOSS OF MARKET ACCESS
The third driver for today’s upgrade is the material decline in market access risk for the Spanish government over the last several months. The Spanish Treasury has had no difficulty in funding its substantial borrowing requirements in the capital markets, and at significantly lower interest rates than 12-15 months ago. The cost at issuance for the Treasury stood at 2.45% in 2013, compared to a peak of 4.6% in July 2012.
In Moody’s view, this has been driven to a large extent by the European Central Bank’s (ECB) policy announcements and actions, but also by the evident improvements in the Spanish economy and the government’s track record of policy implementation. Moody’s notes that the share of foreign investors in the government bond market has declined, while domestic banks have increased their bond holdings substantially over the past 12-18 months. While this increases the linkage between the sovereign and the domestic banking system, it also provides some protection against a sudden stop in funding for the sovereign. Moody’s also believes that the risk of contagion from negative events elsewhere in the euro area has declined.
RATIONALE FOR POSITIVE OUTLOOK
The positive outlook on the Baa2 rating reflects Moody’s expectations that improvements in the economy and the government’s fiscal position will continue over the forecast horizon. More specifically, Moody’s expects the economic recovery to gather speed in the course of 2014 with domestic demand — particularly business investment — contributing positively to growth. The rating agency also expects wage moderation to continue, deepening the important competitiveness gains achieved to date. In Moody’s central scenario, the budget deficit is expected to be gradually reduced over the coming years.
WHAT COULD MOVE THE RATING UP/DOWN
Moody’s would consider upgrading Spain’s government bond rating if the rating agency anticipated a reversal of the upward trajectory in Spain’s debt-to-GDP ratio against the backdrop of a resumption of significant growth.
Conversely, the outlook and eventually the rating would come under downward pressure if the economic improvement or fiscal consolidation stalled. While significantly less likely than a year ago, significant further bank recapitalisation needs or renewed and sustained concerns over market access would also be negative for the rating.
GDP per capita (PPP basis, US$): 30,058 (2012 Actual) (also known as Per Capita Income)
Real GDP growth (% change): -1.6% (2012 Actual) (also known as GDP Growth)
Inflation Rate (CPI, % change Dec/Dec): 2.9% (2012 Actual)
Gen. Gov. Financial Balance/GDP: -10.6% (2012 Actual) (also known as Fiscal Balance)
Current Account Balance/GDP: -1.1% (2012 Actual) (also known as External Balance)
External debt/GDP: [not available]
Level of economic development: High level of economic resilience
Default history: No default events (on bonds or loans) have been recorded since 1983.
On 18 February 2014, a rating committee was called to discuss the rating of the Spain, Government of. The main points raised during the discussion were: The issuer’s economic fundamentals, including its economic strength, have materially increased. The issuer’s institutional strength/framework, have improved. The issuer has become less susceptible to event risks. An analysis of this issuer, relative to its peers, indicates that a repositioning of its rating would be appropriate.
The principal methodology used in these ratings was Sovereign Bond Ratings published in September 2013. Please see the Credit Policy page on http://www.moodys.com for a copy of this methodology.
The weighting of all rating factors is described in the methodology used in this rating action, if applicable.