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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 in local- and in foreign-currency at A- and has revised the Outlooks to Positive from Stable. Scope has furthermore affirmed the short-term issuer ratings at S-1 in local- and in foreign-currency, with Stable Outlooks.

Summary

The revision of the Outlook on Spain’s A- sovereign credit ratings to Positive from Stable reflects the following rating drivers:

1. Enhanced economic resilience despite challenging global economic conditions, given Spain’s recent strong economic performance and positive labour market dynamics, supported by previous reform implementation. The execution of Next Generation EU funds and increased investment spending contribute to robust GDP growth prospects compared to peers. Fundamental improvements in Spain's external competitiveness and sustained private sector deleveraging support long-term economic stability.
    
2. Strengthening fiscal fundamentals are supported by sustained revenue growth from increased social security contributions and moderated expenditures, reflected in improvements in the primary balance offsetting projected moderate interest expenses.

Rating sensitivities

The Positive Outlook reflects Scope’s opinion that risks to the ratings are skewed to the upside over the coming 12 to 18 months.

The ratings could be upgraded if there was a notable improvement, individually or collectively, in: i) growth prospects, surpassing our baseline projections, indicating, for example, increased potential growth; and/or ii) public finances, putting public debt on a firm downward trajectory.

Conversely, the Outlooks could be reversed to Stable if: i) low medium-term GDP growth and/or protracted fiscal deterioration reversed the trend of the declining debt-to-GDP trajectory; and/or ii) an increase in domestic political risk materially deteriorated Spain's economic conditions and government finances.

Rating rationale

First driver of the Outlook revision: enhanced economic resilience

Amid challenging global economic conditions, Spain's economy has shown strengthened resilience compared to its rating peers, demonstrating robust GDP growth and positive labour market dynamics since the Russian invasion of Ukraine in 2022. In 2023, Spain's real GDP growth reached an estimated 2.5%, significantly surpassing the euro area's growth of around 0.5%. The steady growth in Spain’s record-high social security contributions underscore positive employment trends.

Scope forecasts Spain's GDP growth to reach 1.9% in 2024 despite high interest rates and subdued external demand from the euro area. The execution of Next Generation EU funds has gained momentum, supporting private consumption. With a resilient banking sector, higher investment, household spending supported by declining saving rates, job creation, and improving real wages, Scope projects sustained growth at 2.1% in 2025. Inflationary pressures are easing, with projected rates of 3.0% in 2024 and 2.3% in 2025.

Spain has undertaken significant labour market reforms and adjustments to its pension system, even before the inconclusive elections last year, thus reducing risk of policy implementation as major reforms have been realised, including an increase in the average retirement age, supporting labour supply. Continued political tensions between the central government and Catalonia's pro-independence factions may impact legislative dynamics, contingent upon agreements between the central government and regional authorities.

Key labour market reforms, such as the promotion of open-ended contracts and training initiatives, have significantly supported employment growth in high-value-added sectors over the past five years further bolstering Spain's economic resilience. However, sustaining employment will depend on productivity growth, emphasizing the importance of ongoing investment in skills development.

By bolstering competitiveness, visible in an improving trade balance and increasing FDI inflows in crucial sectors like manufacturing and transport services, Spain has substantially reduced its vulnerability to external shocks. Spain has steadily reduced external debt, despite a temporary increase during the pandemic. Improvements in the net international investment position, shifting from -84.9% of GDP in 2020 to -56.3% in 3Q2023, underscore this positive trajectory.

Scope expects that recurring current account surpluses averaging around 2.0% of GDP over the medium-term will support further reductions in external debt alongside EU grant inflows, contributing to sustained improvement of Spain's net international investment position. Spain's private sector has adeptly used the prolonged period of low-interest rates to restructure, resulting in limited private sector debt. This supports the outlook for sustained long-term economic growth.

Second driver of the Outlook revision: strengthening fiscal fundamentals

Despite the absence of an approved budget for 2024, Spain has extended the 2023 budget and initiated preparations for the 2025 budget, in line with the key guiding principles outlined in the stability programme. The projected consolidation is facilitated by the government's Rebalancing Plan, endorsed by the Council of Ministers in December 2023. These budgetary measures are expected to remain in place at least until regional elections in Catalonia are held in May. Scope expects continuity in the 2024 budget framework with minimal room for changes, bolstered by this year's favourable settlement for the regions.

The reinforcement of fiscal fundamentals in Spain is underscored by high nominal GDP expansion, steady revenue growth, driven mainly by the sustained expansion of social security affiliations, and a restraint in spending growth. This is reflected in the improvement of the primary balance, with Scope projecting a transition from an estimated deficit of -1.7% of GDP in 2023 (compared to -2.6% in 2022) to -0.4% in 2024.

The budgetary improvement this year is facilitated by the gradual removal of temporary measures addressing the energy crisis, resulting in savings of 0.8 GDP points. Additionally, the improvement is also supported by the better-than-targeted budget outcome achieved in 2023, with a deficit of 3.7% of GDP compared to the targeted 3.9%, further contributing to the positive fiscal trajectory. The projected rise in interest expenses, from 2.4% of GDP in 2023 to 2.6% of GDP in 2024, is expected to contribute to a budget deficit of 3.0% of GDP for Spain in 2024.

By 2025, Scope projects Spain to achieve balanced primary accounts, which is supported by structural shifts, such as the growing formalization of the informal economy resulting from labour reforms, reductions in tax evasion, and the expansion of e-commerce platforms, contributing to Spain's tax revenue growth prospects. The gradual expiration of temporary support measures will bolster revenue growth.

Scope's baseline is a gradual reduction of the government deficit to around 2.8% of GDP until 2028 without additional measures, compared to a reduction to 2.5% by 2026 outlined in the stability programme. Over the medium term, social contributions are predicted to be less dynamic, while expenditure is forecasted to modestly increase, particularly in pension and interest expenditures. Scope projects a decreasing trend in public consumption and social benefits spending, offset by increased investment in capital formation and transfers. These projections exclude spending from recovery funds, treated as neutral in public accounts under Spain's stability programme.

Rating challenges: low productivity growth, growing structural budget pressure, high public debt

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

Spain’s relatively lower productivity and per capita incomes, coupled with a still high structural unemployment underscore the necessity for structural reforms to support sustained economic growth. Despite robust economic growth in recent years, productivity gains have lagged peers, with labour productivity at approximately 82% of the euro area average in 2022. Additionally, Spain's per capita GDP remains about 25% below the euro area average, limiting its growth potential, estimated at 1.75%.

Long-term expenditure patterns, particularly driven by the accelerated ageing population, including pension and healthcare costs, alongside rising military spending and interest expenses, are exerting pressure on Spain's budget. These pressures are anticipated to intensify from 2026 onwards, potentially requiring additional adjustments should interest rates exceed current projections. Fiscal dynamics between the central government and regional administrations, contingent upon agreements reached with regional authorities, could further significantly impact fiscal outcomes. The increase in the settlement of regional and local financing systems will partially counterbalance the withdrawal of the measures in 2024.

With public debt standing at 107.7% of GDP in 2023, a decrease from 111.6% in 2022, Spain faces the challenge of high indebtedness, expected to decline only gradually to 104.9% in 2024 and return to pre-pandemic levels by 2028 (98.2%). This slow decline is driven by the government's budgetary consolidation, alongside the impact of elevated interest rates and expenditure pressures, despite robust nominal economic growth.

Sovereign Quantitative Model (SQM) and Qualitative Scorecard (QS)

Scope’s SQM, which assesses core sovereign credit fundamentals, signals a first indicative credit rating of ‘a-’ for the Kingdom of Spain. Under Scope’s methodology, the indicative rating receives i) a one-notch positive adjustment for the euro as reflecting a global reserve currency, and ii) no negative adjustment for political risks. On this basis, a final SQM quantitative rating of ‘a’ is reviewed by the Qualitative Scorecard (QS) and can be changed by up to three notches depending on the size of Spain’s qualitative credit strengths or weaknesses compared against a peer group of sovereign states.

Scope identified the following credit weaknesses in the QS: i) fiscal policy framework; and ii) social factors. On aggregate, the QS generates a one-notch negative adjustment for Spain’s credit ratings. This results in final A- long-term ratings on the Kingdom of Spain. A rating committee has discussed and confirmed these results.

Factoring of Environment, Social and Governance (ESG)

Scope explicitly factors in ESG issues in its ratings process vis-à-vis the sovereign-rating methodology’s stand-alone ESG sovereign-risk pillar, which holds a significant 25% weighting under the quantitative model (SQM) and 20% weight under the methodology’s qualitative overlay (QS).

As captured by Scope’s quantitative model, Spain's environmental transition risks include: i) water scarcity and biodiversity loss due to climate change, which could impact agriculture, industry, and urban areas, posing challenges to water management and sustainable usage; ii) agricultural resilience, with agriculture being a significant contributor to greenhouse gas emissions in Spain, making adaptation to changing climate conditions while maintaining agricultural productivity crucial; and iii) energy transition challenges, involving significant investments and infrastructural changes. Concurrently, Spain’s investments in renewable energy are driving the green transition towards achieving carbon neutrality by 2050.

Spain's demographic challenges pose significant implications for its economic growth trajectory and fiscal balance in the medium term. Recent reforms have yielded progress, but Spain still faces entrenched dualism in its labour market. Quantitative assessments highlight disparities in social risks when compared to peers, stemming from elevated old-age dependency ratios and income inequality. These challenges arise from an ageing population, declining birth rates, and relatively subdued wage levels. Addressing these complexities necessitate prolonged fiscal commitments, as reflected by a negative qualitative adjustment in Spain's social factors category.

In governance, Scope assesses Spain using five of the six governance indices from the World Bank: control of corruption, rule of law, voice and accountability, governance effectiveness, and regulatory quality. Spain compares favourably to its peers in these areas, reflecting robust institutions. However, the ability to enact reforms, such as addressing long-term expenditure patterns driven by an aging population, and negotiating agreements with regions, poses significant challenges for the current minority government.

Rating committee
The main points discussed by the rating committee were: i) domestic economic risk; ii) public finance risks, including fiscal policy 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/or Outlooks, (Sovereign Rating Methodology, 29 January 2024), is available on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
The model used for these Credit Ratings and/or Outlooks is (Sovereign Quantitative Model Version 3.0), 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 and 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/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, Senior Director
Person responsible for approval of the ratings: Giacomo Barisone, Managing Director
The Credit Ratings/Outlooks were first released by Scope in January 2003. The Credit Ratings/Outlooks were last updated on 6 October 2023.

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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