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Rating Action:

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

15 Jul 2022

Frankfurt am Main, July 15, 2022 -- Moody's Investors Service ("Moody's") has today affirmed the Government of Spain's long-term issuer ratings and senior unsecured bond ratings at Baa1. The senior unsecured MTN programme ratings and senior unsecured shelf ratings have also been affirmed at (P)Baa1, while the other short-term programme rating has been affirmed at (P)Prime-2. The outlook remains stable.

The affirmation of Spain's ratings balances the following key drivers:

1. Public support measures help contain economic fallout from pandemic-related shocks;

2. An elevated debt burden and rising interest costs;

3. Spain's comprehensive reform agenda, although upcoming elections raise implementation risks.

The stable outlook balances Spain's efforts to enhance the economy's shock absorption capacity and improve the functioning of its labour market with Moody's views that negative near-term risks prevail as inflationary pressures rise and the real economy slows in a highly uncertain global environment. Under Moody's base case scenario for fiscal strength, the gradual decline in public debt will be offset by weaker debt affordability metrics as the European Central Bank (ECB) is tightening its monetary policy stance.

Spain's long-term local and foreign-currency bond country ceilings remain unchanged at Aa1. For euro area countries, a six-notch gap between the local currency ceiling and the local currency rating as well as a zero-notch gap between the local currency ceiling and foreign currency ceiling is typical, reflecting benefits from the euro area's strong common institutional, legal and regulatory framework, as well as liquidity support and other crisis management mechanisms. It is also in line with Moody's view of de minimis exit risk from the euro area.

RATINGS RATIONALE

RATIONALE FOR AFFIRMATION OF Baa1 RATINGS

FIRST DRIVER: PUBLIC SUPPORT MEASURES HELP CONTAIN ECONOMIC FALLOUT FROM PANDEMIC-RELATED SHOCK

The first driver of the affirmation of the rating reflects Spain's resilience to shocks. Prior to the coronavirus pandemic, the reduction in Spain's macroeconomic imbalances enhanced economic actors' shock absorption capacity, as reflected in stronger balance sheets for households and corporates, and sounder financial institutions. The 2020 pandemic-induced recession, with a 10.8% drop in real GDP, was severe but short-lived, followed by a 5.1% rebound in 2021.

Furlough scheme ERTEs (Expediente de Regulación Temporal de Empleo) provided a key support to millions of employees (3.6 million at the peak in April 2020), smoothing the immediate impact on the labour market and reducing the risks of permanent scarring. As a result, employment is now already higher than at its pre-crisis peak, supporting the reduction in unemployment. Spain's economic resilience compares favourably to the Baa1 median, with stronger economic as well as governance metrics: Spain benefits from a large and wealthy economy combined with mature institutions that are only partly offset by lower trend growth and higher volatility relative to peers.

Moody's forecasts Spain's real GDP to expand by 3.5% in 2022. Domestic demand is expected to support the recovery, with private consumption to benefit from the rebound in the tourism sector as both domestic and international travelling resumes. Data for January to May 2022 shows that tourism arrivals reached 78% of their 2019 levels, and bookings for the next few months point to a strong summer season.

However, in the context of the military conflict in Ukraine and its ripple effects on the global economy, the balance of risks is tilted to the downside. While Spain's energy dependence on Russia is relatively low, high gas and oil prices, coupled with rising food, goods and services inflation will negatively affect household incomes and corporate margins. Moody's forecasts Spain's average inflation to reach 8% this year, mainly driven by energy and food prices.

For 2023 and 2024, Moody's expects Spain's real GDP growth to reach 1.6% and 2.0%, broadly in line with the economy's potential. In parallel, average inflation is expected to reach 3.4% and 2.0%, respectively. The projection assumes a gradual implementation of public investments under the Recovery and Resilience Programme (RRP). As a result, Spain's potential growth will likely be driven by capital investment in the coming years, while labour's contribution would be mildly positive.

SECOND DRIVER: AN ELEVATED DEBT BURDEN AND RISING INTEREST COSTS

The second driver of the rating affirmation is based on Spain's debilitated fiscal metrics. In 2021, the slight decline in the debt burden to 118.4% of GDP from an elevated level (120.0% of GDP in 2020) reflected a marked reduction in the deficit (6.9% of GDP from 10.3% of GDP) as revenues accelerated and pandemic-related expenditures receded. Debt affordability continued to improve in both years, with a decline in the cost of issuance despite higher borrowing needs as the ECB's very accommodative monetary policy supported euro area sovereigns. Spain's fiscal metrics compare unfavourably to the Baa1 median, with a much higher debt burden and higher interest payments-to-GDP.

Looking ahead, Moody's forecasts Spain's general government deficit to reach 5.6% of GDP in 2022, 4.7% of GDP in 2023 and 4.3% of GDP in 2024. Revenue growth should remain dynamic, benefitting in the short-term from higher inflation, targeted tax increases and a reduction in the informal economy as the share of card payments increase. On the spending side, phasing out of pandemic-related expenditures is expected to take off 2.6% of GDP of public spending in 2022 compared to 2021.

However, as for its economic scenario, Moody's believes that risks to the fiscal projection are to the downside considering the elevated uncertainty and the government's measures to smooth the impact of the military conflict in Ukraine on consumers and businesses. Adding the measures announced in March and June 2022, the government estimates the packages total cost to reach EUR 15.1 billion (1.3% of GDP) this year.

Regarding debt affordability, the shift in monetary policy by the ECB will raise Spain's interest payments over time. While the lengthening of Spain's debt average maturity to above 8 years from 6.4 years in 2011-2012 largely shields the country from an abrupt rise in interest payments, Moody's expects Spain's debt affordability to gradually weaken as interest rates normalize.

Under its baseline scenario, Moody's forecasts Spain's interest-to-revenue ratio to rise from 5.0% in 2021 to almost 6.0% in 2025, and the interest-to-GDP ratio from 2.2% in 2021 to 2.6% in 2025. The precise path of debt affordability metrics will depend on the speed of normalization and idiosyncratic factors including market perception as well as the potential mitigating impact of the anti-fragmentation instrument whose details are yet to be announced by the ECB.

THIRD DRIVER: SPAIN'S COMPREHENSIVE REFORM AGENDA, ALTHOUGH UPCOMING ELECTIONS RAISE IMPLEMENTATION RISKS

The third driver of the action reflects the commitment from the Spanish authorities to conduct reforms in the context of the RRP. Approved by the European authorities in 2021, Spain's RRP includes 102 reforms and 112 investments for a total grant component amount of EUR 69.5 billion (5.8% of GDP). To date, Spain has received EUR 19 billion, including a first performance-based tranche for EUR 10 billion following the fulfilment of 52 milestones in the areas of sustainable mobility, energy efficiency, decarbonisation, and public administration, among others.

Since then, two important reforms were enacted in December 2021 in the fields of labour market and pensions. These reforms translate into law agreements struck between trade unions and business representatives: in Moody's view, this means that both reforms are likely to be long-lasting, providing economic actors and civil society with more predictable rules while raising new challenges for the country's public finances.

The labour market reform aims to reduce the duality in the Spanish economy, a structural challenge impairing the country's potential growth. At 67.7% in 2021, the employment rate of the 20-to-64-year category stood 5.4 percentage points below the EU's average, a gap broadly in line with the 2010 to 2019 average. Coupled with a significant increase in firms' internal flexibility via the simplification of the Spanish furlough scheme (ERTEs) and the creation of the sectoral and cyclical "RED" mechanisms, Moody's believes that the limitation of available contracts is likely to enhance the functioning of Spain's labour market, laying the ground for a reduction in the country's elevated structural unemployment, especially among younger workers. The focus on training and upskilling is also likely to enhance the workforce's ability to transition between jobs and sectors.

The pension reform aims to ensure the system's long-term sustainability, maintaining pensioner's purchasing power and protecting intergenerational equity. Measures include the indexation of pensions to inflation, the creation of an "intergenerational equity mechanism" funded by an increase in social security contributions and a new "bonus-malus" system to penalize early retirements and reduce the gap between the effective and the legal retirement age. The reform is primarily guided by social acceptability considerations, implying additional long-term costs for the budget. Based on official estimates, Moody's projects the current set of measures to increase pension spending by at least 1% of GDP by 2050. Hence, if left unchanged, the increase in pension spending would put further pressure on Spain's long-term fiscal sustainability. Moody's notes that the government is working on a new set of measures to offset the costs of the first reform, although it is still too early to assess their potential impact.

With regional elections scheduled for May 2023 and general elections to be held before the end of 2023, Moody's sees risks to reform implementation as the focus shifts to shorter term concerns. While fulfillment of the targets and milestones contained in the RRP will continue to drive the agenda, a more fragmented political landscape is likely to weigh on policy choices, both from a reform and a fiscal perspective.

RATIONALE FOR STABLE OUTLOOK

The stable outlook balances Spain's efforts to enhance the economy's shock absorption capacity and raise potential growth with Moody's views that negative near-term risks prevail as inflationary pressures rise and the real economy slows in a highly uncertain global environment. Under Moody's base case scenario, the gradual decline in public debt will be offset by weaker debt affordability metrics as the ECB tightens its monetary policy stance.

ENVIRONMENTAL, SOCIAL AND GOVERNANCE CONSIDERATIONS

Spain's exposure to environmental risks is moderately negative (E-3). Our assessment is driven by Spain's relatively high exposure to physical climate risk, in particular sea level rise, water and heat stress as well as recurring wildfires.

We assess Spain's social issuer profile score as moderately negative (S-3), reflecting good housing availability, and high-quality health & safety and access to basic services. Spain faces high risks with regards to population ageing and unfavourable labour market outcomes, with high youth and long-term unemployment and a high incidence of precarious, short-term employment contracts. The authorities have taken steps to address some of these challenges in the 2021 labour market reform.

Spain's institutions and governance profile supports its rating, and this is captured by a positive governance issuer profile score (G-1). Spain scores well on global surveys assessing voice & accountability, regulatory quality and government effectiveness. The effectiveness and credibility of fiscal policy is somewhat lower than for other EU countries, reflecting continued high structural budget deficits and a high public debt level despite reasonably robust growth. The benefit of significant EU recovery funds linked to the implementation of structural reforms provides an important anchor and supports a high degree of resilience, mitigating in particular the above S risks.

Spain's ESG Credit Impact Score is neutral to low (CIS-2), reflecting moderately negative exposure to environmental and social risks, and, like many other advanced economies, very strong governance and in general strong capacity to respond to shocks.

GDP per capita (PPP basis, US$): [not available] (also known as Per Capita Income)

Real GDP growth (% change): 3.5% (2022) (also known as GDP Growth)

Inflation Rate (CPI, % change Dec/Dec): 6% (2022)

Gen. Gov. Financial Balance/GDP: -5.6% (2022) (also known as Fiscal Balance)

Current Account Balance/GDP: 0.3% (2022) (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 12 July 2022, a rating committee was called to discuss the rating of the Spain, Government of. Other views raised included: The issuer's economic fundamentals, including its economic strength, have not materially changed. The issuer's fiscal or financial strength, including its debt profile, has not materially changed.

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

WHAT COULD CHANGE THE RATINGS UP

Upward pressure would result if the Spanish authorities were able to put the country's fiscal deficit on a firm downward trend over the next two to three years, leading to a pronounced decline in Spain's elevated debt load. Implementation of further cost-saving measures to ensure the pension system's long-term sustainability and mitigate the impact of ageing on healthcare and other social spending would be credit positive, as would the effective deployment of the RRP to bolster Spain's growth potential.

WHAT COULD CHANGE THE RATINGS DOWN

A worsening of Spain's fiscal imbalances due to an absence of a determined policy response or deficit-increasing measures would exert negative pressure on the rating. A permanent loss in output weakening Spain's public finances compounded by an erosion in monetary policy effectiveness resulting in higher-than-expected rise in interest payments would also be credit negative. Finally, inability to effectively use the European funds would weigh on our assessment of Spain's institutions and governance.

The principal methodology used in these ratings was Sovereign Ratings Methodology published in November 2019 and available at https://ratings.moodys.com/api/rmc-documents/63168. Alternatively, please see the Rating Methodologies page on https://ratings.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 on https://ratings.moodys.com/rating-definitions.

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 issuer/deal page for the respective issuer on https://ratings.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 https://ratings.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://ratings.moodys.com/documents/PBC_1288235.

At least one ESG consideration was material to the credit rating action(s) announced and described above.

The Global Scale Credit Rating on this Credit Rating Announcement was issued by one of Moody's affiliates outside the UK and is endorsed by Moody's Investors Service Limited, One Canada Square, Canary Wharf, London E14 5FA under the law applicable to credit rating agencies in the UK. Further information on the UK endorsement status and on the Moody's office that issued the credit rating is available on https://ratings.moodys.com.

Please see https://ratings.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 issuer/deal page on https://ratings.moodys.com for additional regulatory disclosures for each credit rating.

Olivier Chemla
Vice President - Senior Analyst
Sovereign Risk Group
Moody's Deutschland GmbH
An der Welle 5
Frankfurt am Main, 60322
Germany
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

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

Releasing Office:
Moody's Deutschland GmbH
An der Welle 5
Frankfurt am Main, 60322
Germany
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

No Related Data.
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