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Rating action

Scope Ratings GmbH has today affirmed the Kingdom of Spain’s A- long-term issuer and senior unsecured local- and foreign-currency ratings, along with its short-term issuer rating of S-1 in both local and foreign currency. All Outlooks remain Stable.

Summary and Outlook

Scope’s affirmation of Spain’s A- ratings is underpinned by the following credit strengths: i) Spain’s status as a euro area member; ii) the country’s large and diversified economy; and iii) the gradual reduction of external and financial imbalances. These factors allowed for the implementation of a countercyclical fiscal response to the Covid-19 shock, support the medium-term outlook for the Spanish economy and increase the country’s resilience to economic shocks in the context of rising energy and commodity prices and global uncertainty.

Rating challenges include: i) high public and external debt levels; ii) elevated structural unemployment and low productivity growth; and iii) structural fiscal deficits and adverse demographic developments in form of a rapidly ageing and declining population, placing structural pressure on public finances and weighing on growth potential.

The Stable Outlook reflects Scope’s view that risks to the ratings are balanced over the next 12 to 18 months.

The A-/Stable ratings/Outlooks could be upgraded if, individually or collectively: i) reforms are introduced that further raise the country’s growth outlook and/or ii) public finances improve meaningfully, putting public debt on a firm downward trajectory.

Conversely, the ratings/Outlooks could be downgraded if: i) a weaker than expected economic recovery and/or protracted fiscal deterioration would result in a weakened debt sustainability; and/or ii) reforms are delayed or introduced adversely impacting the economic and fiscal outlook.

Rating rationale

Spain’s A- ratings reflect Spain’s status as a euro area member which allows it to benefit from strong European institutional support in the form of EU monetary and fiscal policies. Support from the European Central Bank proved key throughout the Covid-19 crisis in anchoring market access for the EU’s most indebted member states, including Spain. The ECB implemented a number of policy innovations which reinforced the potency of its support compared to previous crises, first among them the increased flexibility across sovereigns and time in its asset purchases. In this process, the share of Spanish public debt held within in the Eurosystem increased from 18% at end-2019 to 28% by end-2021, lowering the level of risk born by the private sector and adding stability to the overall debt structure. The ECB’s expansive policies helped Spain to benefit from stable, low debt costs throughout the crisis, with the 10-year government bond yield remaining below 0.4% for most of the 2020-2021 period, allowing the government to fund large-scale supportive fiscal policies which cushioned the impact of the shock on households and corporates. As is the case with peers, the improvement of Spain’s economic outlook and the expectation of monetary policy normalisation have caused interest rates to increase steadily in recent months. Scope expects monetary policy to remain relatively accommodative and real interest rates to remain low in the medium term, thus facilitating the gradual consolidation of Spain’s public finances.

European Union institutional support was further reinforced by the roll-out of the NextGenerationEU recovery fund, which marked a new decisive step towards stronger fiscal integration within the union. Spain is the second largest benefiter from the plan and is set to receive EUR 69.5bn in grants under the Recovery and Resilience Facility, representing 5.6% of the country’s pre-crisis GDP. Despite delays in its implementation, with only 45% of the available funds having been disbursed at end-2021, this financial support provides significant fiscal space for the Spanish government to boost growth and reduce regional disparities while carrying out structural reforms.

The A- ratings are also underpinned by the country’s large and diversified economy, driven by high value-added activities.

After suffering one of the deepest contractions in economic output in the EU in 2020, with GDP falling by 10.8%, the Spanish economy grew by 5.1% last year, putting GDP at about 3.8% below its-end 2019 level. The delay in the recovery is largely related to Spain’s specialisation in sectors most impacted by the pandemic, tourism in particular, as well as in industries affected by global supply chain disruptions, including automobile. The labour market outlook has improved markedly, with the unemployment rate returning below its pre-crisis level in 2021 Q4 and the total number people of persons employed edging above 20m for the first time since 2008. Scope expects the recovery to stay on course in the medium-term, with GDP growth forecasted at 4.6% in 2022 and 3.3% in 2023. The growth momentum should be supported by the rebound in international tourism following the phase-out of travel restrictions as well as by the roll-out of Spain’s EU-funded Recovery, Resilience and Transformation Plan.

Scope expects Spain to be less impacted by the conflict between Ukraine and Russia than most euro area peers. Its overall trade exposure to Russia and Ukraine is low, with the two countries accounting for 1% and 1.7% of Spanish exports and imports, respectively. The country benefits from strategic advantages in terms of energy infrastructure compared to other European peers in the context of the crisis, due to its low reliance on Russian oil and gas exports and its pipeline connections to North Africa. Spain’s LNG terminals account for the highest regasification capacity in Europe, with 6 operational terminals. Despite these resilience factors, Spain is reliant on energy imports, which cover more than 70% of final energy consumption.

Inflation (HICP) had accelerated to 3.0% on average in 2021, up from -0.3% in 2020, largely driven by supply bottlenecks, energy prices as well as by the release of pent-up demand. The outbreak of the war in Ukraine caused spikes in energy and raw materials prices, as well as supply-chain disruptions, which have further fueled price increases, pushing inflation up to 9.8% in March 2022. The headline inflation rate receded somewhat to 8.3% in April following a moderation in energy price increases, while underlying inflation (excluding food and energy prices) remained on an upwards trend and reached 4.4% (+1pp from March), pointing to the broadening of price pressures. The European Commission recently agreed to allow Spain and Portugal to place a temporary cap on natural gas and coal prices used by power plants by both countries, in light of the low degree of interconnection between their national electricity networks and the rest of Europe. This mechanism should reduce price pressures in Spain and partially alleviate their impact on households.

Finally, Spain’s A- ratings are supported by long run improvements in external and financial imbalances. Spain holds a good record of steady current account surpluses, averaging around 2% of GDP between 2012 and 2019. The current account balance deteriorated over the crisis, largely owing to global supply chain disruptions on some Spain’s key export sectors, automotive in particular combined with a dip in foreign demand. The rise in global energy prices will continue to weigh on the trade balance in the medium term. Scope then expects temporary headwinds to gradually dissipate and global tourism flows to resume, allowing Spain to gradually return to its pre-crisis level of surpluses. The net international investment position is large, negative, at about 64% of GDP as of end-2021 but decreased significantly since 2012 (-23pp) following the sustained period of external surpluses.

Financial imbalances have similarly been on a long-term improving trend. Private sector balance sheets had improved significantly in the run-up to the pandemic, with the level of private debt as a share of GDP declining to around 190% by 2019, a more than 85pp decrease from 2010, following decreases in both households and non-financial corporates indebtedness. Vulnerabilities remain in part owing to the large share of variable rate household mortgage debt, especially in a context of expected monetary tightening.

Despite these credit strengths, Spain’s ratings are challenged by several weaknesses.

First, Spain’s government debt-to-GDP ratio is elevated, at 118.7% at end-2021, among the highest in the euro area. Despite declining in 2021 due to the rebound in economic activity, it still stood about 20pp above pre-pandemic levels. Though Scope expects debt-to-GDP to remain on a downward trend in the medium-term due to the recovery in economic output, down to around 111% by 2025, it should then stabilise at this elevated level, around 15pps above pre-pandemic levels. The decline in public debt was already only very gradual before the health crisis, by about 5pp between 2014 and 2019, down to 95.5% of GDP. This moderate improvement was largely driven by favourable tax revenue growth and a decrease in the cost of debt. The general government primary balance remained negative, at -0.8% of GDP in 2019, also reflecting the fiscal support provided by the Spanish central government to the regions. A persistent primary deficit combined with a high level of public indebtedness constrains Spain’s capacity to absorb future economic shocks.

Second, Spain is faced with long-standing labour market challenges, with elevated structural unemployment and weak productivity growth. Despite recent improvements, Spain’s structural unemployment rate (around 14%) remains among the highest in the euro area. At the same time, the persistent duality of the labour market, with a widespread use of temporary contracts (about 21% of all employed, against 11% for the euro area) and elevated youth and long-term unemployment rates, adversely impacts the country’s growth potential. The Spanish economy has also recorded lacklustre labour productivity growth over the recent period, with annual productivity gains averaging at 0.6% over 2010-19. The recently passed labour market reform aims to reduce the elevated share of temporary work contracts by making it harder for employers to recourse to unjustified fixed-term contracts. Other measures including a strengthening of collective bargaining structures and a push for vocational training should help reduce the level of structural unemployment.

Finally, Spain’s demographic developments count among the most adverse in Europe, specifically, regarding the rapidly ageing and declining working population. The European Commission expects Spain’s working-age population (aged 20-64) to decrease by about 16% by 2070, less than Italy (-23%) and Portugal (-31%), but well above the 6-8% decline expected for higher-rated sovereigns such as Belgium and France. As a result, the old-age dependency ratio is set to increase to around 63 by 2070 from 32 in 2019, in line with that of Italy (66) and Portugal (67), but above France’s (57) and Belgium’s (53). This will likely limit Spain’s growth potential and have a significant impact on the financing of the pension system. The government’s recent pension reform, which included the cancellation of previously introduced sustainability mechanisms and the indexation of pensions on CPI, could further exacerbate these financing challenges. The IMF estimates that these changes could increase the pension spending-to-GDP ratio by up to 3.5pps by 2050, thus adding a significant hindrance to the consolidation of public finances over the long-term.

Core Variable Scorecard (CVS) and Qualitative Scorecard (QS)

Scope’s Core Variable Scorecard (CVS), which is based on the relative rankings of key sovereign credit fundamentals, provides an indicative rating of ‘a’ for the Kingdom of Spain, after including adjustment for reserve currency under Scope’s methodology. As such, under Scope’s methodology, an ‘a’ indicative rating can be adjusted by the Qualitative Scorecard (QS) by up to three notches depending on the size of relative qualitative credit strengths or weaknesses against a peer group of countries.

For Spain, the following relative QS credit weaknesses have been identified: i) fiscal policy framework; and ii) social risks.

The QS generates one negative notch adjustment and indicates a sovereign credit rating of A- for Spain.

A rating committee has discussed and confirmed these results.

Factoring of environment, social and governance (ESG)

Scope explicitly factors in ESG sustainability issues during its rating process via the sovereign methodology’s stand-alone ESG sovereign risk pillar, with a 20% weighting under the quantitative model (CVS) as well as in the methodology’s qualitative overlay (QS).

Governance factors are explicitly captured in Scope’s assessment of ‘institutional and political risk’ under its methodology, in which Spain obtains relatively strong scores on a composite index of six World Bank Worldwide Governance Indicators, reflecting a strong and stable institutional framework.

Socially related credit factors are similarly captured under Scope’s CVS. Increasing labour force participation rates are counterbalanced by high income-inequality and significantly increasing old-age dependency ratios. Spain also has a particularly high share of young people neither in employment nor in education and training (‘NEET’) compared with peers.

Finally, regarding environment risks, Spain scores relatively well under the CVS on carbon emissions per unit of GDP and its exposure and vulnerability to natural disaster risk metrics. However, the sovereign scores weaker on resource risks, specifically for the ecological footprint of its consumption compared with the available biocapacity within its borders. Spain also counts among the most vulnerable countries to the adverse effects of climate change compared to European peers. Scope notes positively that the Spanish government moved its 2025 energy transition targets contained in its National Energy and Climate Plan forward to 2023 to boost the country’s economic recovery. This should foster investment for renewable energies, the renewal of housing stock and infrastructure for electric mobility.

Rating Committee
The main points discussed by the rating committee were: i) domestic economic risk, including growth potential and resilience; ii) public finance risks, including fiscal framework and debt dynamics; iii) external risks; iv) financial stability risks; v) ESG considerations; and vi) peer developments.

Methodology
The methodology used for these Credit Ratings and/or Outlooks, (Rating Methodology: Sovereign Ratings, 8 October 2021), is available on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
Information on the meaning of each Credit Rating category, including definitions of default, recoveries, Outlooks and Under Review, can be viewed in ‘Rating Definitions – Credit Ratings, Ancillary and Other Services’, published on https://www.scoperatings.com/governance-and-policies/rating-governance/definitions-and-scales. Historical default rates of the entities rated by Scope Ratings can be viewed in the Credit Rating performance report at https://scoperatings.com/governance-and-policies/regulatory/eu-regulation. Also refer to the central platform (CEREP) of the European Securities and Markets Authority (ESMA): http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. A comprehensive clarification of Scope Ratings’ definitions of default and Credit Rating notations can be found at https://www.scoperatings.com/governance-and-policies/rating-governance/definitions-and-scales. Guidance and information on how environmental, social or governance factors (ESG factors) are incorporated into the Credit Rating can be found in the respective sections of the methodologies or guidance documents provided on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
The Outlook indicates the most likely direction of the Credit Ratings if the Credit Ratings were to change within the next 12 to 18 months.

Solicitation, key sources and quality of information
The Credit Ratings were not requested by the Rated Entity or its Related Third Parties. The Credit Rating process was conducted:
With Rated Entity or Related Third Party Participation    NO
With Access to Internal Documents                                 NO
With Access to Management                                           NO
The following substantially material sources of information were used to prepare the Credit Ratings: public domain.
Scope Ratings considers the quality of information available to Scope Ratings on the Rated Entity or instrument to be satisfactory. The information and data supporting these Credit Ratings originate from sources Scope Ratings considers to be reliable and accurate. Scope Ratings does not, however, independently verify the reliability and accuracy of the information and data.
Prior to the issuance of the Credit Rating action, the Rated Entity was given the opportunity to review the Credit Ratings and/or Outlooks and the principal grounds on which the Credit Ratings and/or Outlooks are based. Following that review, the Credit Ratings were not amended before being issued.

Regulatory disclosures
These Credit Ratings and/or Outlooks are issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0. The Credit Ratings and/or Outlooks are UK-endorsed.
Lead analyst Jakob Suwalski, Director
Person responsible for approval of the Credit Ratings: Dr. Giacomo Barisone, Managing Director
The Credit Ratings/Outlooks were first released by Scope Ratings on 30 June 2017. The Credit Ratings/Outlooks were last updated on 16 July 2021.

Potential conflicts
See www.scoperatings.com under Governance & Policies/EU Regulation/Disclosures for a list of potential conflicts of interest related to the issuance of Credit Ratings.

Conditions of use / exclusion of liability
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