Fitch Sees Glimmers of Hope in Spain as it Holds Rating

Fitch Ratings has affirmed Spain’s long-term foreign and local currency issuer default ratings (IDRs) at BBB with a negative outlook. The short-term foreign currency IDR is affirmed at F2 and the country ceiling at AAA.

The credit ratings agency (CRA) said that its ratings rationale reflected the following key factors:

•  Fitch projects that Spain’s public debt will remain under 100% of gross domestic product (GDP) even given some assumed fiscal slippage and a continuation of the country’s deep recession in 2013. This projection also incorporates the cost to the state of bank support, which the CRA judges to be affordable.
• Although these debt projections are sensitive to shocks, Spain’s investment-grade rating reflects Fitch’s opinion that the sovereign maintains some fiscal headroom, albeit significantly reduced. The authorities’ commitment to reducing public borrowing is strong, but the fiscal deficit will take several more years to be eliminated in structural terms.
• Spain’s rating is lower than that of other large advanced economies, reflecting the relatively large risks to creditworthiness posed by its economic and financial adjustment within the eurozone. Growth prospects are uncertain, all sectors of the economy are relatively indebted and unemployment is exceptionally high.
• Spain’s balance of payments adjustment within the eurozone is proceeding at a faster pace than expected. Fitch has revised up its forecast for Spain’s current account balance and now expects an external balance in 2013 and a small surplus in 2014. While partly a result of its economic contraction, this improvement also reflects relatively strong exports and competitiveness gains.
• The Spanish sovereign has demonstrated its financing flexibility and resilience during the crisis. Public debt’s average tenor has been gradually shortening but remains longer than rating peers at just over six years. Moreover, the announcement of the European Central Bank’s (ECB) Outright Monetary Transactions (OMT) programme has materially eased stresses in the peripheral eurozone sovereign bond markets.
• The rating remains supported by Spain’s relatively high value-added and diversified economy.

Fitch added that Spain’s negative outlook reflects the following risk factors that may, individually or collectively, result in a downgrade of the ratings:

• Failure to place the public debt ratio on a firm downward path over the medium term.
• Greater uncertainty over the continuity of Spain’s economic and fiscal policy stance.
• A deeper and longer recession than currently forecast, which would undermine the fiscal consolidation effort, and could erode bank asset quality further than currently anticipated.
• A sustained deterioration in fiscal funding conditions caused by an intensification of the eurozone crisis. This would feed through to tighter private sector lending conditions and deepen the recession.

Developments that may, individually or collectively, lead to a stabilisation of the outlook include:

• A surer prospect of a sustained economic recovery leading to a stabilisation of the labour market and improved fiscal dynamics.
• Further evidence that Spain’s fiscal strategy is yielding substantial deficit reduction in 2012-13, which would lower the risks around Fitch’s debt/GDP forecasts.
• Further improvement in Spain’s international competitiveness and implementation of growth-enhancing reforms.

Financing conditions have been relatively benign in recent months. The OMT programme reduces the tail risk of a sovereign liquidity crisis for Spain and is supportive of the rating. While it remains uncertain as to whether Spain will request further official assistance, the request itself would be neutral for the rating.

The CRA also said that its rating reflects the following assumptions:

Growth: Fitch forecasts that the economy will begin to recover in 2014 as headwinds from fiscal austerity and financing conditions ease. As is currently the case, the recovery will be primarily driven by net exports; domestic demand will remain subdued for a longer period. The CRA maintains its assumption that medium term potential growth is 1.5%.
Public finances: Fitch projects that public debt will peak in 2014-15 at around 96% and decline gradually thereafter, assuming an effective interest rate close to current levels. Medium-term deficit forecasts assume some slippage relative to official targets.
Banks: Fitch judges that the contingent liabilities from the banking sector have been adequately sized and that capital injections required from the Spanish sovereign will not exceed €60bn. Nonetheless, if the recession is deeper and longer than currently anticipated, the risk that the government may be required to make further injections of capital cannot be discounted. While the CRA has not factored in the public debt relief that would arise from a partial transfer of Spanish bank stakes to the European Stability Mechanism (ESM), this cannot be ruled out over the medium term.
Domestic policy: The current rating is based on the assumption that early parliamentary elections will not be called before 2015; that the current administration will broadly maintain its current policy stance; that there will be no constitutional crisis in Spain; and that future governments will keep public debt/GDP on a gently declining path in latter half of the decade.
Eurozone policy: The current rating reflects Fitch’s judgement that Spain will retain market access and that EU intervention would be requested in a timely manner, if needed to avoid unnecessary strains on sovereign liquidity. Fitch assumes there will be progress in deepening integration within the currency union in line with commitments by eurozone policy makers. It also assumes that the risk of eurozone breakup remains low.

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