London 25 April 2014
Fitch Ratings has upgraded Spain’s Long-term foreign and local currency Issuer Default Ratings (IDRs) to ‘BBB+’ from ‘BBB’ The issue ratings on Spain’s senior unsecured foreign and local currency bonds have also been upgraded to ‘BBB+’ from ‘BBB’. The Outlooks on the Long-term IDRs are Stable. The Country Ceiling was raised to ‘AA+’ from ‘AA’ and the Short-term foreign currency IDR affirmed at ‘F2’.
KEY RATING DRIVERS
The upgrade reflects the following key rating drivers, along with their respective weights:-
– Risks to Spain’s creditworthiness have decreased since the sovereign was downgraded to ‘BBB’ in June 2012. Financing conditions have improved, the economic outlook is more certain, and the risk of Spanish banks posing an additional burden on the sovereign has diminished.
-Spain’s fiscal track record over the past two years has been strong, in our opinion. Its headline fiscal deficit (excluding bank support) declined by 2.5% of GDP in 2012-13, despite a 2.2% drop in nominal GDP over the same period.
-Spain’s balance-of-payments adjustment has been driven by robust export performance as well as domestic demand contraction. The current account registered a surplus of 0.8% of GDP in 2013, the first in nearly three decades. This improvement would help contribute to reducing Spain’s high net external debt stock (92% of GDP) over the medium term.
-Structural economic reforms of the labour market, pension system, fiscal framework and financial sector that have been enacted by the authorities since the start of the crisis have improved the longer-term outlook for the Spanish sovereign.
Spain’s ‘BBB+’ IDRs also reflect the following key rating drivers:
-The general government deficit remains large, which we forecast at 5.7% of GDP for 2014. Public debt/GDP has risen 11pp per year on average since 2008 and we expect the ratio to peak at 104% of GDP in 2016.
-The ratings are supported by Spain’s high value-added and diversified economy, which is slowly adjusting after its credit bubble. Strong improvements in productivity since 2008 have been broad-based and private sector deleveraging is underway.
-Spain’s ratings are lower than those of other large advanced economies, reflecting the higher risks to creditworthiness posed by its economic and financial adjustment within the eurozone. Medium-term growth prospects are weak, all sectors of the economy remain heavily indebted and unemployment is exceptionally high.
-Although Spain’s public debt dynamics remain sensitive to shocks, its ratings reflect our opinion that the sovereign maintains modest fiscal headroom. The authorities’ commitment to reducing public borrowing is strong, but the structural fiscal deficit will take several more years to be eliminated.
The following risk factors may, individually or collectively, result in a positive rating action:
-Sustained economic recovery leading to an improvement of the labour market and fiscal dynamics, supported by the implementation of growth-enhancing reforms
-Further progress in deficit reduction, lowering the risks to debt dynamics
-Improvement in Spain’s external balance sheet
The following risk factors may, individually or collectively, result in a negative rating action:
-Erosion in public debt dynamics (from lower nominal GDP growth, slower deficit reduction, and/or crystallisation of contingent liabilities)
-Reversal of Spain’s economic and fiscal policy stance (eg weakening commitment to fiscal consolidation)
-Current account returning to a large deficit
We project that public debt will peak in 2016 at 104% and decline gradually thereafter, assuming an effective interest rate close to current levels. Medium-term forecasts assume some slippage relative to official public deficit targets. The agency maintains its potential growth assumption of 1.5% in the second half of the decade.
We assume that banking sector risks have been adequately captured by the authorities in the context of the 2012-13 financial-sector reform programme (supported by the European Stability Mechanism, ESM) and that additional capital injections required from the Spanish sovereign will not be large. Nonetheless, further state support for Spanish banks cannot be ruled out, especially if the economy underperforms our expectations. We assume no official debt relief on Spain’s existing EUR41.3bn loan from the ESM.
The ratings are based on the assumption that early parliamentary elections will not be called before 2015; that the current administration will broadly maintain its policy stance; that there will be no constitutional crisis in Spain; and that future governments will keep public debt/GDP on a gently declining path in the latter half of the decade.
We assume Spain and the eurozone as a whole will avoid long-lasting deflation, such as that experienced by Japan from the 1990s. However, 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.
We assume the gradual progress in deepening fiscal and financial integration at the eurozone level will continue; key economic imbalances within the currency union will be slowly unwound; and eurozone governments will tighten fiscal policy over the medium term.