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Rating action

Scope Ratings GmbH (Scope) has today upgraded the Kingdom of Spain’s (Spain) long-term issuer and senior unsecured debt ratings in local- and in foreign-currency to A from A- and revised the Outlooks to Stable, from Positive. Scope has furthermore affirmed Spain’s short-term issuer ratings at S-1 in local- and in foreign-currency, with Stable Outlooks.

The upgrade of Spain’s long-term credit ratings reflects the following rating drivers:

1. Strengthened economic resilience and sustainability. Spain's robust GDP growth is driven by increased economic diversification and positive labour market trends, which reflect past reforms and positive net migration flows. Additionally, Spain's effective use of substantial Next Generation EU funds has enhanced its economic sustainability, positioning the country favourably against its peers and contributing to solid long-term growth prospects.
    
2. Sustained fiscal consolidation, driven by robust revenue dynamics and controlled spending growth, with energy-related measures mostly phased out. These factors support steady improvements in the primary balance, which Scope expects to be balanced by 2025, offsetting moderate interest expense increases. The central government's strategy allows regional governments to maintain their fiscal positions without further tightening, supporting overall fiscal stability and policy implementation. Additionally, the recent shift in Catalonia's government towards a closer alignment with national policies is likely to reduce fiscal uncertainties.

Key rating drivers

First driver of the upgrade: strengthened economic resilience and sustainability

Scope expects Spain's dynamic, service-driven economy to outpace the growth of major European economies over the next two years, with projected improvements in the external position. Despite global economic challenges, Spain's economy has demonstrated resilience, achieving a robust 2.5% GDP growth in 2023, significantly surpassing the euro area's growth of 0.5%. Scope has revised its 2024 GDP growth forecast for Spain upwards from 1.9% to 2.4%, following stronger-than-expected contributions from net export and robust private consumption in the first half of the year. For 2025, Scope forecasts slightly lower growth of around 2.2%, primarily due to expected fiscal adjustments, yet still outperforming euro area peers. Growth is driven by increasing household consumption, supported by the rebound in real wages, job creation, and population growth. Investment, which remains below its pre-pandemic level, is also expected to increase, driven by momentum from the NGEU programme and a gradual loosening in financing conditions. Net external demand is expected to contribute positively to GDP growth in 2024, but this impact will likely neutralize in 2025 as imports are projected to outpace exports due to strong domestic investment and moderate growth among Spain’s key euro area trading partners. Headline inflation is projected to decrease, with average annual rates expected to fall to 3.0% in 2024 and 2.3% in 2025.

Medium-term growth prospects benefit from structural improvements in the country’s economic structure and strong labour market dynamics, with significant contributions from positive net migration flows and labour market reforms that have raised participation rates and improved job quality. Labour market reforms promoting permanent contracts and training initiatives have yielded significant employment growth in high-value sectors. Furthermore, output and employment gains have been driven by emerging, higher value-added sectors, including telecommunications and advanced manufacturing. This dynamism is also reflected in the material external competitiveness gains achieved in non-tourism service exports over recent years, as recently highlighted by the IMF.¹ Moving forward, Scope expects Spain to continue diversifying its economy away from traditional sectors like tourism and construction. These trends should support further improvements in the country’s economic resilience and labour productivity.

Additionally, sizable EU fund inflows, particularly for infrastructure and green energy investments, further support Spain’s medium-term growth prospects. The execution of Next Generation EU funds has gained momentum, supporting investment growth. Funds allocated to Spain under its Recovery and Resilience Plan amount to EUR 79.9bn in grants (alongside EUR 83.2bn available in loans, for a total amount equivalent to 11.5% of 2023 GDP), EUR 48.0bn of which had been disbursed as of end-July 2024. The full and timely implementation of EU funds is key to sustain investment momentum and Spain’s growth outlook.

Finally, the enhanced sustainability of the Spanish economy is reflected by the pronounced improvement of the country’s external position in recent years. The current account balance posted a surplus averaging 1.8% annually in the ten years to 2023, a significant upswing from a 4.8% deficit on average in the previous decade. After moderating to 0.6% in 2022, amid weak external demand and higher nominal commodity imports, the current account surplus improved to 2.6% last year. Steady surpluses have led to a significant reduction in external vulnerabilities in recent years, with the net international investment position improving to -53% of GDP by end-2023, from -96% at end-2014.

Second driver of the upgrade: sustained fiscal consolidation

Spain's fiscal consolidation is bolstered by strong nominal GDP growth, steady revenue increases driven by expanding social security contributions, and controlled spending growth. This has led to an improvement in the budget balance, with Scope projecting a deficit reduction from 3.6% of GDP in 2023 to 3.0% in 2024. The removal of temporary energy crisis measures and better-than-expected budget outcomes in 2023 have further supported this positive fiscal trajectory. While interest expenses are projected to rise, structural reforms, such as further formalizing the informal economy and reducing tax evasion, are expected to support revenue growth. These measures should help achieve balanced primary accounts and align the budget deficit with the government's revised stability target of a 2.5% of GDP fiscal deficit for 2025, down from the previous target of 2.7%.

Over the medium term, Scope forecasts a sustained reduction in the government deficit to 2.0% for 2026 and 1.8% for 2027, despite moderate increases in pension and interest expenditures. The upcoming fiscal consolidation will be largely driven by the central government, rather than regional governments. This approach allows regional and local governments to maintain their current aggregate budget balances without requiring further fiscal tightening on their part. This strategy aims to ensure that sub-sovereign entities retain the flexibility to manage their finances effectively, supporting overall fiscal stability across different levels of government. The expenditure limit at the general government level, confirmed in July 2024, ensures that no additional spending measures can be introduced this year unless they are covered by reallocating existing budget allocations.

Moreover, the change of government in Catalonia, which contributes approximately 19% of Spain's GDP, results in a shift from a pro-independence administration to one more aligned with national policies. This is likely to enhance cooperation between the regional and central governments and thus supports policy implementation. This political realignment should reduce the economic and fiscal uncertainties previously associated with parties supporting Catalonia’s independence movement.

On this basis, Scope expects the public debt-to-GDP to remain on a gradual declining trend over the coming years, decreasing to 103.2% by end-2025 from 105.2% by end-2024, and further to about 98% by 2029. This trajectory is underpinned by expectations of moderate but steady primary surpluses and favourable nominal growth, which should outweigh a projected increase in interest expenses. The latter should be gradual, reflecting Spanish authorities’ ability to access capital markets at still-comparatively moderate financing costs and a long average maturity (7.9 years as of July 2024).

Rating challenges: modest productivity, elevated unemployment, structural budget pressure, high public debt

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

Firstly, Spain's relatively low productivity levels and per capita incomes, combined with persistently high structural unemployment, highlight the ongoing need for policy action to sustain long-term economic growth. Despite recent improvements, Spain's productivity remains moderate relative to euro area peers, with output per person employed standing at about 81% of the euro area average in 2023. Persistent challenges to productivity growth include moderate levels of business investments and domestic market fragmentation, as recently highlighted by the European Commission.² Furthermore, despite significant employment gains over recent years, Spain’s unemployment rate remains the highest in the EU, at 11.5% (seasonally adjusted) as of June 2024, significantly above the EU average of 6.0%.

Secondly, Spain’s fiscal outlook is affected by long-term spending pressures, which may require further fiscal adjustments. Population ageing-related costs are expected to rise steadily over coming years, up to a forecasted 25.1% of GDP by 2030 (up 1.1pps from 2022, against a 0.2pps increase for the EU on aggregate).³ Scope notes that Spain's defence expenditure, estimated at 1.3% of GDP in 2024, remains well below NATO's 2.0% guideline, potentially adding budgetary pressure amid sustained geopolitical uncertainty.⁴ In addition, the fiscal dynamics between the central government and regional administrations, which depend on agreements with regional authorities, could also influence overall fiscal outcomes over the medium-term. This factor is more pronounced beyond 2027 as the stability targets for regional governments during the 2025-2027 period do not foresee further fiscal consolidation on aggregate.

Finally, with public debt at 107.7% of GDP in 2023, Spain's high indebtedness remains a critical credit concern, with a gradual decline projected to return to pre-pandemic levels only by 2029. High public debt, amid still elevated interest rates and rising spending pressure, limits Spanish authorities’ fiscal space and ability to effectively face potential shocks.

Outlook and rating sensitivities

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

Upside scenarios for the long-term ratings and Outlooks are if (individually or collectively):

1. Marked improvement in external competitiveness resulting in a stronger external position.
    
2. Firm downward trajectory of government debt to GDP.
    
3. Sustained economic growth, for instance driven by improved labour markets and diversification into emerging sectors.

Downside scenarios for the long-term ratings and Outlooks are if (individually or collectively):

1. Weaker economic growth or public finances, reversing the declining debt-to-GDP trajectory.
    
2. Higher domestic political risk, materially deteriorating Spain's economic conditions and public finances.

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).

With respect to environmental factors, Spain scores broadly in line with the average of euro area sovereigns under the SQM. The model considers comparatively high greenhouse gas emissions per capita and high ecological footprint of its consumption compared with available capacity, all the while accounting for the Spanish economy’s relatively low carbon emissions per units of GDP and moderate exposure to natural disaster risks, as evaluated via the ND-GAIN Index. Still, climate change-related phenomena, such as droughts and biodiversity losses present significant transition risks and may impact agriculture, industry, and urban areas. While further efforts are necessary to achieve transition towards carbon neutrality by 2050, Scope notes that Spanish authorities have made significant progress in some key policy areas, including in bolstering renewable energy production, which covered three quarters of electricity generation in 2023.

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. Additionally, significant regional disparities exacerbate these challenges, with substantial differences in economic performance, unemployment rates, and demographic trends across various regions. Scope reflects these challenges with 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.

Rating driver references
1. IMF, Spain: Selected Issues; IMF Country Report No. 24/153, May 2024
2. European Commission, 2024 European Semester: Country Reports - Spain, June 2024
3. European Commission, 2024 Ageing Report, April 2024
4. NATO, Defence Expenditure of NATO Countries (2014-2024), June 2024

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 and/or Outlooks 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 Credit Ratings: Alvise Lennkh-Yunus, Managing Director
The Credit Ratings/Outlooks were first released by Scope Ratings in January 2003. The Credit Ratings/Outlooks were last updated on 22 March 2024.

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, as well as a list of Ancillary Services and certain non-Credit Rating Agency services provided to Rated Entities and/or Related Third Parties.

Conditions of use / exclusion of liability
© 2024 Scope SE & Co. KGaA and all its subsidiaries including Scope Ratings GmbH, Scope Ratings UK Limited, Scope Fund Analysis GmbH, and Scope ESG Analysis GmbH (collectively, Scope). All rights reserved. The information and data supporting Scope’s ratings, rating reports, rating opinions and related research and credit opinions originate from sources Scope considers to be reliable and accurate. Scope does not, however, independently verify the reliability and accuracy of the information and data. Scope’s ratings, rating reports, rating opinions, or related research and credit opinions are provided ‘as is’ without any representation or warranty of any kind. In no circumstance shall Scope or its directors, officers, employees and other representatives be liable to any party for any direct, indirect, incidental or other damages, expenses of any kind, or losses arising from any use of Scope’s ratings, rating reports, rating opinions, related research or credit opinions. Ratings and other related credit opinions issued by Scope are, and have to be viewed by any party as, opinions on relative credit risk and not a statement of fact or recommendation to purchase, hold or sell securities. Past performance does not necessarily predict future results. Any report issued by Scope is not a prospectus or similar document related to a debt security or issuing entity. Scope issues credit ratings and related research and opinions with the understanding and expectation that parties using them will assess independently the suitability of each security for investment or transaction purposes. Scope’s credit ratings address relative credit risk, they do not address other risks such as market, liquidity, legal, or volatility. The information and data included herein is protected by copyright and other laws. To reproduce, transmit, transfer, disseminate, translate, resell, or store for subsequent use for any such purpose the information and data contained herein, contact Scope Ratings GmbH at Lennéstraße 5, D-10785 Berlin.