By Jakob Suwalski and Brian Marly, Sovereign and Public Sector

The proposal will improve the regions’ debt metrics without impacting our view on the sovereign (A/Stable), since the proposed debt relief does not impact Spain’s fundamentals given that regional debt is already consolidated into the general government accounts.

However, despite the debt relief, highly indebted regions will remain vulnerable, as budget pressures in these regions are primarily driven by rising non-financial expenditures, a structural issue that remains unaddressed.

The central government’s debt relief plan will have highly uneven impacts across regions (Figure 1), with debt forgiveness ranging from 19% to around 50% of total debt. The Canary Islands (around 50%) and Andalusia (47%) will receive the highest proportion of forgiveness relative to total debt.

In absolute terms, three of the 15 regions will absorb about 57% of the proposed debt relief plan: Andalusia (EUR 18.8bn), Catalonia (EUR 17.1bn) and Valencia (EUR 11.2bn). Still, despite this significant relief, Catalonia’s and Valencia’s total debt would remain very high, limiting credit improvements. Moreover, as the regions’ average interest payment burden is already low at 1.9% of operating revenue in 2023, down from 6.7% in 2014, the debt write-off will offer only limited relief for financing costs.

Uncertainty surrounding the scope and timing of the implementation of the proposal

The proposal was approved by the fiscal council on 26 February 2024 but still requires amendments to the Organic Law on Regional Financing (LOFCA), as unilateral debt forgiveness is not currently permitted. Additionally, parliamentary approval is not expected before the end of 2025, which could introduce further delays and uncertainty.

Political resistance remains strong, with 11 conservative-led regions boycotting the vote and demanding a new regional financing system, a transitional equalisation fund to support under-funded regions, and greater co-governance of European funds.

Additionally, affected regions such as Valencia have called for the unlocking of funds under the central government’s FLA (Fondo de Liquidez Autonómica) credit line to address the impact of natural disasters. Similarly, Catalonia, a key debt relief beneficiary whose political support is needed to approve the general government’s budget, could also leverage negotiations around further autonomy demands.

The varying financial situations of the regions also adds complexity. Many regions have relied heavily on funds disbursed under the FLA and Fondo de Facilidad Financiera (FF) credit lines since 2012, making them a dominant category in the composition of Spain’s regional debt. By Q3 2024, approximately 63% of total regional debt was in the form of FLA/FF loans, highlighting the long-term dependence of many regions on central government funding.

However, since Madrid (A/Stable) has no FLA/FF debt and Asturias, the Canary Islands, Castile-Leon, and Galicia have lower FLA/FF loan amounts than the proposed debt relief, a broader restructuring approach and political considerations is needed beyond just cancelling FLA/FF debt. The EUR 21bn in debt relief allocated to these five regions covers only EUR 5.7bn in FLA/FF debt, leaving a residual gap of EUR 15.3bn that must be addressed through other restructuring mechanisms.

Proposed debt relief lowers ratios but fails to ensure long-term sustainability

The proposed debt relief would lead to a significant reduction in debt-to-operating revenue ratios across Spain’s autonomous communities (Figure 2), lowering the sector aggregate from 152% to 114%.

Under the proposal, Madrid could receive EUR 8.6bn in debt relief, reducing its debt burden by 33pp to 103% of 2024 operating revenue if cancelled outright. Without relief, we forecast Madrid’s debt-to-operating revenue ratio to gradually decline to around 120% by 2028, driven by steady revenue growth and disciplined borrowing. However, if the state phases in the EUR 8.6bn of relief by gradually assuming debt in line with maturities, for instance, by allocating additional state transfers to Madrid given its lack of FLA/FF debt, Madrid’s debt ratio could fall further to 90% by 2028, accelerating its fiscal consolidation.

Before debt relief, regional debt ratios ranged from 57.4% (Canary Islands) to 291.3% (Valencia), highlighting significant fiscal disparities. After relief, the spread narrows, with most regions falling between 50% and 150%. However, highly indebted regions like Valencia, Catalonia, and Murcia remain significantly above the sector average despite notable reductions.

These regions face long-term sustainability challenges due to high growth in non-financial expenditure, underscoring the need for a more comprehensive reform of the financing framework beyond this one-time relief measure.

Changes to enhance Spain’s fiscal equalisation system, structural budgetary support and conditionality, and better multi-level governance could positively impact our assessment of central government support, and thus potentially the ratings of lower-rated autonomous communities.

Potential impact on market access and key challenges ahead

We expect seven regions – Asturias, Canary Islands, Castile-Leon, Galicia, Madrid, Navarre, and the Basque Country – to rely fully on private-sector financing this year, with Madrid and the Basque Country leading issuance.

Andalusia’s mixed funding model (80% market, 20% state) may set a precedent for others transitioning from state liquidity support. However, most regions will remain reliant on extraordinary funding, highlighting the need for structural reforms to ensure sustainable market access.

Key risks of the proposed debt forgiveness programme include the lack of conditionalities such as explicit financial discipline requirements, raising concerns over moral hazard. Without structural reforms to Spain’s regional financing system, some regions will likely continue accumulating debt. Highly transfer-dependent regions may still record deficits and rely on central government liquidity mechanisms in the future, limiting the programme’s long-term effectiveness.