- We have revised our average 2014-2016 real GDP growth projections for Spain upward to 1.6% from 1.2% reflecting the effects of labor and other structural reforms.
- We are therefore raising our long- and short-term sovereign credit ratings on Spain to ‘BBB/A-2′ from ‘BBB-/A-3′.
- The outlook is stable, reflecting our current view that risks to the ratings on Spain will remain balanced over the next two years.
On May 23, 2014, Standard & Poor’s Ratings Services raised the long- and short-term foreign and local currency sovereign ratings on the Kingdom of Spain to ‘BBB/A-2’ from ‘BBB-/A-3’. The outlook is stable.
The upgrade reflects our view of improving economic growth and competitiveness as a result of Spain’s structural reform efforts since 2010, including the 2012 labor reforms. Reflecting the effects of these reforms and our expectation that monetary policy in the eurozone will remain highly accommodative, we have revised our average 2014-2016 GDP growth projections for the Spanish economy to 1.6% from 1.2%. We also expect that recovering employment will contribute to improvements in the country’s fiscal position and the stabilization of financial system asset quality.
Preliminary Eurostat estimates of first-quarter 2014 real GDP growth indicate that the economy grew 1.6% on an annualized basis. While this figure may be subject to considerable revisions, it nevertheless appears to be supported by a gradual recovery in employment growth across a broadening range of sectors, as indicated by social security data, particularly in tourism, but also in manufacturing, as well as in the non-tradeables sector. In our view, recent reforms to the retail sector deregulating opening hours, liberalizing temporary contracts, and business start-ups also appear to be supporting Spain’s economic recovery.
Most competitiveness metrics show considerable gains for the Spanish economy, supporting the economy’s reorientation toward external demand:Unit labor costs have declined by an estimated 8% since 2009 (Eurostat data), the strongest adjustment in the eurozone over the period with the exception of Greece and Ireland. Spain’s export share in global trade has continued to grow. The real effective appreciation of the euro since mid-2012 has so far not undermined Spanish companies’ favorable export performances, but could pose a risk should it continue unabated. Very low inflation, at close to zero since September 2013, is a reflection of excess economic capacity in the labor market, in our view. This is confirmed by declining wages, especially in the domestic non-tradables sector. At the same time, however, declining nominal earnings have slowed down the process of economy-wide deleveraging. While Banco de España (central bank) data indicates that, between 2010 and 2013, household and corporate debt declined by an estimated 25% of GDP to 206% of GDP (even as GDP itself was declining), public sector indebtedness increased by some 30 percentage points to almost 92% of GDP over the same period. Therefore, total leverage in the economy (corporates, households, and general government) stood at more than 300% of GDP in the third quarter of 2013, only surpassed by Ireland and Portugal in the eurozone. When the euro was introduced in 1999, the Spanish economy’s total debt ratio was just over 150% of GDP.
We believe that Spain’s recovering economy will support fiscal consolidation and enable public debt to gradually decline, as private debt continues to be gradually paid down. We view stronger tax receipts so far in 2014 as indicating a cyclical improvement in the budgetary position.
We also continue to see net export growth as an important contributor to GDP, given expectations of further deleveraging in the public and private sectors. Nevertheless, in our view the still very high debt levels in the economy will probably lead to an extended period of relatively subdued domestic demand as companies and households attempt to reduce leverage. Should inflation remain at the extremely low levels of the last six months for extended periods, the deleveraging process might take longer still.
Last year, Spain’s current account was in surplus for the first time since Spain joined the European Economic Community in 1986, implying a net external adjustment of more than 10% of GDP since 2008. Over the last five years, the Spanish economy has become more open; exports are now equivalent to 34% of GDP compared with 27% in 2008, though the large current account adjustment also reflects a 13% decline in nominal domestic demand over the period. Rising current account receipts (CARs), initial private-sector deleveraging, and replacing foreign debt with equity liabilities have enabled a reduction in narrow net external debt to 2.8x CARs in 2013 from a 2009 peak of 3.8x. Despite the decline, we expect that the figure will remain the 12th highest among the 129 sovereigns rated by Standard & Poor’s.
We project that the Spanish government will broadly meet and potentially slightly improve its revised general government budgetary deficit target of 5.5% of GDP in 2014. However, we see risks to achieving the more ambitious 2015 and 2016 budgetary targets of 4.2% and 2.8%, respectively (equivalent to a nominal adjustment of 1.35% of GDP annually). While we believe that the economic recovery will help reduce the deficit–through the cyclical increase in revenues from consumption, and income taxes, as well as gradually reduced unemployment transfers–we believe that without further deficit-reduction measures, the government is unlikely to meet its targets.
We also expect that with the upcoming 2015 regional and general elections, ongoing deep socioeconomic challenges and significantly reduced capital market pressure could lead to fiscal and structural policy slippages. This could jeopardize medium-term government deficit and economic growth targets.
We expect Spain’s net general government debt to increase to about 93% of GDP in 2017 from 88.5% of GDP in 2014, excluding the guarantees related to the European Financial Stability Facility (EFSF; see “S&P Clarifies Its Approach To Accounting For EFSF Liabilities When Rating The Sovereign Guarantors,” published on Nov. 2, 2011, on RatingsDirect). At the same time, average general government interest payments will likely represent about 9% of general government revenues during 2014-2017. Finally, we do not expect the Spanish government to incur additional significant fiscal costs linked to banks’ recapitalization.
The rating remains constrained by what we classify as very high private and public debt levels, a weak external economic balance sheet, and a weak monetary transmission mechanism that appears to be placing parts of Spain’s corporate sector at a competitive disadvantage in terms of relative financing costs. At the same time, we expect persisting tensions between the central government and regional authorities to be contained.
The stable outlook incorporates our current view that risks to Spain’s ratings will remain balanced over the next two years.
We could consider raising the ratings on Spain if:
The budget deficit declines further and general government debt metrics stabilize; or The external position continues to improve, bringing narrow net external debt to below 150% of CARs or markedly easing the cost of or access to financing for the private sector.
The ratings could come under renewed downward pressure if:
Economic growth prospects falter; or It appears to us that net general government debt will likely overshoot 100% of GDP (regardless whether this is due to fiscal slippage, weakening growth, deflationary pressures, or one-off items that push up debt, such as the crystallization of contingent liabilities); or Interest payments rise sustainably above 10% of general government revenues; or Spain’s current account balance weakens again.