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Rating action

Scope Ratings GmbH (Scope) has today affirmed the Kingdom of Spain’s long-term issuer and senior unsecured debt ratings at A- in both local and foreign currency and maintained the Stable Outlook. The short-term issuer rating has been affirmed at S-1 in both local and foreign currency with Stable Outlook.

Summary and Outlook

Scope’s affirmation of Spain’s A- ratings is based on the following credit strengths: i) a large and diversified economy, along with energy independence from Russia, which reduces its susceptibility to geopolitical uncertainties, such as those arising from the Russia-Ukraine conflict; ii) a favourable public debt profile with long maturities, partly mitigating risks associated with the tightening global financing conditions; and iii) a robust institutional framework, bolstered by euro area membership, which enhances its ability to withstand shocks.

Rating challenges include: i) high public debt levels; ii) elevated structural unemployment and low productivity growth; and iii) growing budgetary pressures stemming from long-term spending trends, notably related to accelerated ageing dynamics.

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

The ratings/Outlooks could be upgraded if there was a notable improvement, individually or collectively, in: i) growth prospects, supported by, for example, reform progress; and/or ii) public finances, putting public debt on a firm downward trajectory.

Conversely, the ratings/Outlooks could be downgraded if: i) low GDP growth and/or protracted fiscal deterioration resulted in weaker debt sustainability; and/or ii) reforms were delayed, adversely impacting the economic and fiscal outlooks.

Rating rationale

Spain’s A- ratings are underpinned by the country’s large and diversified economy, which, compared to other European major economies, faces lower susceptibility to energy security concerns arising from the Russia-Ukraine conflict. Energy independence on Russian gas and substantial regasification capacities and connections to North Africa reduce Spain’s vulnerability to Ukraine-related restrictions.

Scope forecasts Spain's 2023 real GDP growth at 2.2%, a 0.4 percentage point increase from the mid-year forecast. The upward revision is attributed to a strong carry-over effect from 2022 and robust performance in H1 2023 that was supported by private consumption and investment. This compares favourably with the performance in the broader Euro area, where economic activity was sluggish in H1 2023, with an average growth projected at 0.9% for 2023. Despite the challenging global economic environment, Spain's external sector has demonstrated resilience by maintaining a current account surplus of 2.0% of GDP in the Q2 2023 (in rolling sum of the last four quarters). This trend is underpinned by a long-term reduction in private sector leverage, deviating from Spain's historical growth patterns, which were often accompanied by growing current account deficits. It contributes to a shift towards more sustainable growth.

Scope expects Spain’s economic expansion in the latter part of 2023 to be subdued due to declining tourism sector, higher interest rates and weakened economic activity in major trading partners, causing Spain's real GDP growth to moderate to 1.8% in 2024, a 0.3 percentage point decrease from Scope’s mid-year projection. Public policies responding to the global energy crisis are expected to be withdrawn by the end of 2023, which will have a negative impact on economic growth in 2024. Reduced private sector leverage and a robust banking sector should partially mitigate financial risks in the Spanish economy in view of tighter financing conditions. However, the rising cost of servicing existing variable-rate debt and refinancing past-due balances has increased, potentially straining indebted parties' incomes.

Annual HICP inflation compares favourably within the euro area and is expected to decline to 3.6% in 2023, driven by the deceleration of energy inflation since Q3 2022. In 2024, Scope expects further gradual easing of inflationary pressures, with a rate of 2.9% in Spain.

Longer-term growth prospects are supported by labour market resilience, improving household purchasing power due to easing prices and rising wages and the implementation of projects under the Recovery and Resilience Facility. According to the Bank of Spain, the combined effects of Spain’s recovery plan and European funds could raise Spain's growth potential from 1.3% to 1.9%. While these factors hold the potential to boost Spain’s economic growth, challenges in realising their full potential remain, including the need for broader political consensus.

The second factor bolstering Spain's A- rating is attributed to the favourable debt profile of the Spanish government and its strong market access. These aspects serve to mitigate risks associated with the tightening global financing conditions.

Spain's borrowing costs are set to rise as markets adjust to post-pandemic inflation and tighter monetary policy, but servicing existing debt will increase moderately. A favourable debt structure, longer maturity (7.9 years compared with 6.2 in 2013), a modest share of inflation-indexed bonds (5% of the total), stable ownership (Banco de España holding 28% of government bonds in Q2 2022) and a substantial deposit buffer amounting to around 12% of GDP offset higher issuance costs and support the sustainability of public debt. Spain's refinancing profile is also more favourable compared to many highly rated peers, given the significant amount of high-coupon bonds maturing this year, suggesting a more gradual impact of higher debt issuance costs.

Finally, Spain's status as a member of the euro area provides essential institutional support, offering access to the robust support provided by the ECB and fiscal policies of the EU and contributing to the country's economic stability and resilience.

Spain has already received EUR 37bn out of the allocated EUR 164bn in EU recovery funds, equivalent to 12.4% of its 2022 GDP. These funds comprise both grants and loans, with EUR 77.2bn in grants and EUR 84bn in loans. Nevertheless, substantial work remains to fully implement the investment strategy associated with these funds and maintaining a broad political consensus will be crucial to this effort.

In light of the inconclusive snap elections this summer and considering that planned key reforms in 2023 were implemented before these elections, there is a reduced risk of an extended political deadlock. Spain has proactively undertaken significant reforms, including labour market reform and adjustments to its pension system, even before the inconclusive elections earlier this year. These reforms have effectively mitigated political uncertainty risks, particularly considering ongoing government formation processes. Neither acting Socialist prime minister Pedro Sánchez nor opposition leader Alberto Núñez Feijóo currently possesses a clear path to forming a parliamentary majority. Such a prolonged situation could potentially impede the implementation of structural fiscal and economic reforms. If this were to result in slower-than-anticipated economic growth, it could present challenges for the government's objectives related to enhancing public finances.

With government debt at 111.6% of GDP in 2023, Spain faces persistent challenges in achieving long-term fiscal sustainability. In 2022, Spain succeeded in reducing this ratio by 5.2 percentage points from the preceding year, and Scope's projections anticipate a further 2.8-point decrease in 2023, resulting in a ratio of 108.8%. This reduction is primarily attributed to robust nominal GDP growth. Scope's projection, indicating a slow decline in the debt ratio with an anticipated figure of 107.0% by the close of 2024, underscores the importance of addressing structural primary deficits.

Despite these key credit strengths, Spain’s ratings face the following challenges:

Second, Spain faces challenges in addressing budgetary pressures stemming from increasing expenses associated with servicing the debt and the effects of aging.

Spain's fiscal outlook improved in 2022: the government deficit declined to 4.8% of GDP, a 2.1 percentage point improvement from the previous year. This was down to robust revenue growth and the gradual removal of Covid measures. However, Scope expects the fiscal deficit to decline only moderately in 2023 to 4.1% of GDP, given increase in pension expenditure because of the annual increase in line with the CPI of the previous year (1.0% of GDP), a deficit of the social security system at 0.5% of GDP and remaining measures to mitigate the Ukraine war and energy crisis impact amounting to 1.1% of GDP in 2023, down 0.3 points from 2022.

Tax revenue growth will likely lose momentum, limiting any further narrowing of the headline budget deficit to about 3.0% of GDP by 2024. Scope anticipates that the European Commission will introduce updated fiscal regulations by the end of the year, incorporating a degree of flexibility in terms of the schedule and approach to achieving fiscal objectives. This adjustment acknowledges the shared difficulties faced by several EU member states, including Spain.

Finally, Spain’s long-standing structural weaknesses include elevated unemployment levels and low productivity growth.

Spain's unemployment rate has recently reached a multi-decade low of 11.6%, indicating a favourable performance in its labour market. This improvement can be attributed to the labour market reform of 2021, which has led to enhancements in job quality. However, employment gains are anticipated to slow down in the medium term, while Spain continues to face one of the highest unemployment rates among euro area countries. Moreover, Spain's per capita GDP diverged from the EU over the last decade, declining from around 85% of the EU average in 2006 to 74% in 2022, primarily due to lower employment rates and sluggish productivity growth compared to EU peers.

The EU recovery facility, which prioritises social development and economic growth, has the potential to foster improved employment rates and enhanced productivity in the upcoming years. However, the effective utilisation of these funds also necessitates strong political effectiveness in implementing the required reforms and policies to effectively address the country's economic issues.

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 an adjustment for the 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 weakness has been identified: i) 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 ratings process via the sovereign methodology’s stand-alone ESG sovereign risk pillar, with a significant 25% weighting under its quantitative model (CVS).

Regarding environment risks, Spain scores well under the CVS on carbon emissions. Compared to European peers, Spain is among the most vulnerable to climate change and scores weaker on resource risks, specifically for the ecological footprint of its consumption compared with the available biocapacity within its borders. Scope notes positively that the Spanish government moved its 2025 energy transition targets contained in its National Energy and Climate Plan forward to 2023. This should support investment for renewable energies, the renewal of housing stock, and infrastructure for electric mobility.

Socially related credit factors are similarly captured under Scope’s CVS. Moderate income inequality and increasing labour force participation rates are counterbalanced by significantly increasing old-age dependency ratios. Compared with peers, Spain also has a particularly high share of young people neither in employment nor in education and training, although the government has been addressing this, including as part of its Recovery and Resilience Plan.

Finally, governance factors are explicitly captured in Scope’s assessment of ‘institutional and political risk’ under its methodology, for which Spain scores strongly on a composite index of six World Bank Worldwide Governance Indicators, reflecting its mature and stable institutional framework. The ruling coalition, despite lacking an absolute parliamentary majority, passed several key legislations, including changes to the pension system and labour market as well as budget bills. However, some uncertainty remains regarding ongoing government formation.

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

Methodology
The methodology used for these Credit Ratings and Outlooks, (Sovereign Rating Methodology, 27 September 2023), is available on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
The model used for these Credit Ratings and Outlooks is (Core Variable Scorecard Model Version 2.1), available in Scope Ratings’ list of models, published under 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    YES
With access to internal documents                                 NO
With access to management                                         YES
The following substantially material sources of information were used to prepare the Credit Ratings: public domain, the Rated Entity.
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 Outlooks and the principal grounds on which the Credit Ratings and Outlooks are based. Following that review, the Credit Ratings were not amended before being issued.
 
Regulatory disclosures
These Credit Ratings and Outlooks are issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0. The Credit Ratings and Outlooks are UK-endorsed.
Lead analyst: Jakob Suwalski, Senior Director
Person responsible for approval of the Credit Ratings: Giacomo Barisone, Managing Director
The Credit Ratings/Outlooks were first released by Scope Ratings on January 2003. The Credit Ratings/Outlooks were last updated on 11 November 2022.

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

Conditions of use / exclusion of liability
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