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Rating Action:

Moody's affirms Spain's Baa1 rating and maintains stable outlook

18 Sep 2020

London, 18 September 2020 -- Moody's Investors Service, ("Moody's") has today affirmed the Government of Spain's issuer rating and senior unsecured bond rating at Baa1. The senior unsecured MTN programme rating and senior unsecured shelf rating have also been affirmed at (P)Baa1, while the other short-term programme rating was affirmed at (P)Prime-2. The outlook remains stable.

The key drivers for today's rating affirmation are as follows:

- The Spanish economy has been heavily impacted by the coronavirus pandemic, but government support measures combined with past progress in restoring competitiveness and reducing macro imbalances should provide for a robust economic recovery next year. The EU recovery funds, of which Spain will be a large beneficiary, should add to the strength of the recovery in the coming years and could also help bolster the Spanish economy's long-term growth potential;

- Spain's fiscal and debt metrics have been and will likely remain weaker than many peers. The public debt ratio is likely to stabilize at around 120% of GDP in the coming years, an unprecedented level for Spain. But improving debt affordability metrics due to the low interest rate environment and lower recourse to bond market funding, will mitigate the impact of higher debt on the country's fiscal strength.

- Spain's complex political dynamics have made it difficult to advance structural reforms in the past several years, although access to the EU funds may provide stronger incentives to advance the reform agenda than in the past.

The stable outlook balances the negative near-term effects of the pandemic on Spain's economic and fiscal prospects with Moody's view of a limited long-lasting damage to Spain's productive capacity. Moody's also expects the public finances to be gradually returned to a more solid position over the coming years. Importantly, Moody's base case assumes that the health crisis can be dealt with without resorting to widespread and severe restrictions on mobility similar to those imposed in April and May.

Spain's long-term country ceilings remain unchanged at Aa1 for foreign and local currency bonds and bank deposits. Spain's foreign-currency short-term bonds and bank deposits country ceilings are unchanged at P-1

RATINGS RATIONALE

RATIONALE FOR AFFIRMATION OF Baa1 RATING

FIRST DRIVER: PANDEMIC IMPACT ON SPANISH ECONOMY WILL BE SEVERE BUT SHOULD BE TEMPORARY

Moody's expects the Spanish economy to be among the most negatively affected countries by the pandemic, with real GDP forecast to contract by around 12.5% this year. Spain's exposure to services sectors such as tourism and hospitality that are heavily affected by the pandemic, as well as the prevalence of small and medium enterprises, are key factors behind this forecast. Since the lifting of restrictions in late May, high-frequency indicators point to a rebound of activity, yet the recovery remains uneven and the risk of renewed restrictions on mobility remains until an effective virus treatment has been found.

On the positive side, the government has put in place important -- and well targeted - measures that should help the economic recovery. Credit guarantees of up to €100 billion have been focused on small and medium-sized companies, the backbone of the Spanish economy, and the sectors most heavily affected. Temporary employment protection schemes (so-called ERTEs) have also been successfully used to limit the increase in unemployment, although Spain has still registered a significantly stronger increase in the rate of unemployment than other EU countries, due to the widespread use of temporary employment contracts. The number of employees affected by ERTEs has fallen by 76% since end-April, pointing to the effectiveness of the schemes.

Secondly, Spain's recovery will be supported by the significant EU funds that will be made available over the coming years, with Spain being the second-largest recipient of the EU's €750 billion so-called Next Generation EU (NGEU) recovery fund. The country stands to receive up to €72.7 billion in the form of non-refundable grants and a further €67.3 billion in loans, and is also eligible for around €21 billion from the EU's fund to support member states' temporary employment support schemes. The EU's overall financial support is thus equivalent to close to 15% of Spain's GDP (estimate for 2020), potentially providing a substantial boost to investment in the coming years. Most of the funds will likely be available during 2022 and 2023, with a smaller amount likely to be disbursed already next year. Moody's expects the Spanish economy to grow by close to 8% next year, and has also raised its growth forecasts for each of the following years.

Thirdly, besides the positive contribution from the EU recovery funds, Spain's economy has become much more balanced and resilient than in the past. The economy is highly diversified, with export growth in the past several years driven to an important extent by non-tourism related services. The current account has been in a sustained surplus since 2013, averaging 2% of GDP. Spain's net external debtor position has improved by more than 20 percentage points of GDP, from a recent peak of 95.9% in 2014 to 74.4% in 2019. The private sector has continuously deleveraged and debt ratios of both non-financial corporations and households are now lower or broadly in line with euro area peers.

SECOND DRIVER: WIDENING OF BUDGETARY DEFICITS WILL BE TEMPORARY AND IMPROVING DEBT AFFORDABILITY WILL MITIGATE THE IMPACT OF HIGHER DEBT ON FISCAL STRENGTH

In line with the view that the economic impact of the pandemic should be transitory, Moody's also expects that the fiscal deterioration will be concentrated on the current year. The government's fiscal measures -- estimated at 4-5% of GDP by the country's independent fiscal council (AIReF) - and the severe GDP contraction will lead to a very large budget deficit this year of around 13% of GDP. In Moody's view, next year's deficit should be materially lower, as growth and tax revenues recover some of this year's losses and many of the measures tail off. Spain's public debt ratio will likely rise to above 120% of GDP this year, registering an increase of over 20 percentage points from 2019, above the average across the largest advanced economies. Under Moody's baseline assumptions, Spain's public debt ratio will only stabilize at that level in the following years, leaving the country's public debt among the highest in the world. A credible medium-term fiscal consolidation plan would be needed to bring the debt back onto a downward trajectory.

An important mitigating factor for the otherwise negative fiscal and debt developments is the very favourable funding environment. Supported by the ECB's quantitative easing programme and despite this year's much higher issuance of government bonds, Moody's expects the government's interest burden on the debt to decline as costlier debt is still being refinanced at lower rates. Under Moody's baseline projections, the ratio of interest payments to general government revenue will be 5.7% this year with further declines likely in coming years, comparing favourably to the peak of 8.9% in 2013 and the median of 8.2% for Baa-rated sovereigns. The Spanish authorities have successfully lengthened the average maturity of the debt, thus reducing refinancing risk and locking in the current low funding costs. Spain's debt affordability will remain strong in the coming years given Moody's expectation of ongoing monetary support as well as the reduced recourse to bond markets due to the EU funding.

THIRD DRIVER: POLITICAL DYNAMICS COMPLICATE ADVANCING STRUCTURAL REFORMS

Spain's divided political landscape - with successive minority governments and four general elections since 2015 - has made it difficult to advance structural reforms in recent years. The lack of a majority government has prevented the passing of a budget bill since 2018 and some planned revenue-raising measures have not been passed in parliament, complicating fiscal consolidation efforts. Key challenges include high structural unemployment with a high share of workers on short-term contracts, low productivity growth and a high structural deficit in the social security system.

In Moody's view, the prospect for significant EU funds could provide stronger incentives to reform than in the past few years, albeit this remains to be seen. The deployment of the funds will be subject to the formulation and delivery of a national programme of reforms in line with EU recommendations. The first key test will be the passage of a 2021 budget. The government has recently implemented a long-standing European Commission (EC) recommendation on a country-wide guaranteed minimum income.

RATIONALE FOR STABLE OUTLOOK

The stable outlook balances the negative impact of the pandemic on Spain's near-term economic and fiscal prospects with Moody's expectation that Spain's economic growth profile has become more resilient and diversified over the past decade. It also reflects the rating agency's expectation of a gradual reduction in Spain's fiscal imbalances and a stabilization or some decline in the public debt burden in the coming years.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS

Environmental risks are not material for Spain's credit profile, although the country has some exposure mostly related to water scarcity and focused on regions in which agriculture remains an important sector, such as Andalucía. Agriculture accounts for around 6% of GDP and around 7-9% of employment in the region, compared to a national average of 2.6% and 4% respectively.

Social risks are material for Spain's credit profile. The country has one of the highest rates of unemployment, much of it of a structural nature, as well as a high share of temporary and precarious employment contracts. Spending pressures linked to the ageing society are significant, and the tensions in Catalunya have been an important factor contributing to political fragmentation and a divisive political landscape. Spain has been hit hard by the outbreak of the coronavirus with substantial implications for public health and safety, and the outbreak will have an at least transitory adverse economic and fiscal impact. The pandemic also adds to the political frictions given that the regional governments are responsible for health care.

Governance risks are material. While Spain scores highly on institutional factors, its scores on the Worldwide Governance indicators are somewhat lower than other euro area countries.

GDP per capita (PPP basis, US$): 41,592 (2019 Actual) (also known as Per Capita Income)

Real GDP growth (% change): 2% (2019 Actual) (also known as GDP Growth)

Inflation Rate (CPI, % change Dec/Dec): 0.8% (2019 Actual)

Gen. Gov. Financial Balance/GDP: -2.8% (2019 Actual) (also known as Fiscal Balance)

Current Account Balance/GDP: 2% (2019 Actual) (also known as External Balance)

External debt/GDP: [not available]

Economic resiliency: a2

Default history: No default events (on bonds or loans) have been recorded since 1983.

On 15 September 2020, a rating committee was called to discuss the rating of the Government of Spain. The main points raised during the discussion were: The issuer's economic fundamentals, including its economic strength, have not materially changed. The issuer's institutions and governance strength, have not materially changed. The issuer's fiscal or financial strength, including its debt profile, has not materially changed. The issuer's susceptibility to event risks has not materially changed.

FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS

Some upward rating pressure would develop in case of a more forceful economic recovery than currently expected, and a return to growth rates above other euro area countries, confirming the rating agency's view that the resilience and competitiveness of the Spanish economy is much improved compared to the past. Moody's expectations under a stronger growth scenario is that it would lead to more positive fiscal outcomes and debt trajectory than currently anticipated.

Both the initial speed of the recovery and Spain's growth performance over the next several years could be stronger than Moody's currently expects if the Spanish authorities manage to effectively use the very significant EU funds at their disposal. The rating agency notes that Spain has many years of experience in absorbing large EU (structural) funds. Spain is also particularly well placed to take advantage of the "green transformation" part of the EU's recovery fund.

Another trigger for a positive rating action would be the presentation of a credible medium-term fiscal plan that gives confidence that the public debt ratio would be gradually reduced over the next years. Moody's recognizes that meaningful fiscal consolidation is unlikely in the near term, given the depth of the contraction in 2020 and the still elevated need to support the recovery in 2021. But the EC has long advocated to raise Spain's relatively low tax revenues as part of a medium-term fiscal consolidation strategy, and there is wide agreement that there is scope in particular on VAT and environmental taxes. In addition, AIReF's spending reviews -- which the government has pledged to implement - have identified significant potential to increase the efficiency of public spending.

Thirdly, a renewed focus on structural reforms could put upward pressure on Spain's rating, in particular reforms to ensure the long-term sustainability of the pension system and reforms to the labour market that safeguard the gains in flexibility and competitiveness that the 2012 reforms brought.

Conversely, the rating would come under downward pressure if the economic recovery currently underway stalled or turned out significantly weaker than under Moody's baseline expectations, possibly due to the re-imposition of a nation-wide lockdown, leading to a further rise in public sector indebtedness in the coming years. The economic recovery could also be significantly weaker than under Moody's baseline expectations if the pandemic resulted in a more severe permanent damage to Spain's productive capacity, for instance due to longer-lasting changes in consumer behavior affecting the crucial tourism and hospitality sectors. The rating would also come under downward pressure if the Spanish authorities proved unable to make full and effective use of the EU funds. Moody's considers that coordination between the central government and the regional administrations is likely to be one of the main challenges to the funds' execution.

The principal methodology used in these ratings was Sovereign Ratings Methodology published in November 2019 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1158631. Alternatively, please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.

The weighting of all rating factors is described in the methodology used in this credit rating action, if applicable.

REGULATORY DISCLOSURES

For further specification of Moody's key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. Moody's Rating Symbols and Definitions can be found at: https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_79004.

For ratings issued on a program, series, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series, category/class of debt, security or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

The ratings have been disclosed to the rated entity or its designated agent(s) and issued with no amendment resulting from that disclosure.

These ratings are solicited. Please refer to Moody's Policy for Designating and Assigning Unsolicited Credit Ratings available on its website www.moodys.com.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Moody's general principles for assessing environmental, social and governance (ESG) risks in our credit analysis can be found at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1133569.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Kathrin Muehlbronner
Senior Vice President
Sovereign Risk Group
Moody's Investors Service Ltd.
One Canada Square
Canary Wharf
London E14 5FA
United Kingdom
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

Yves Lemay
MD-Sovereign/Sub Sovereign
Sovereign Risk Group
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

Releasing Office:
Moody's Investors Service Ltd.
One Canada Square
Canary Wharf
London E14 5FA
United Kingdom
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

No Related Data.
© 2020 Moody's Corporation, Moody's Investors Service, Inc., Moody's Analytics, Inc. and/or their licensors and affiliates (collectively, "MOODY'S"). All rights reserved.

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