DBRS Confirms Autonomous Community of Catalonia at BB (high), Stable Trend

DBRS Ratings Limited (DBRS) confirmed the Long-Term Issuer Rating of the Autonomous Community of Catalonia at BB (high) and its Short-Term Issuer Rating at R-4. The trend on all the ratings is Stable.

KEY RATING CONSIDERATIONS

The ratings are underpinned by (1) the region’s positive economic indicators and the slow but continued improvement in its fiscal performance; and (2) the financing support provided by the Kingdom of Spain (rated A, Stable, by DBRS) to the regional government. DBRS continues to consider that the political risk in the region, although it has eased throughout 2018, still offsets some of the improvements in the underlying economic and fiscal performance recorded in the region.

DBRS views the region’s Long-Term Issuer Rating as being currently constrained at the BB (high) level by Catalonia’s high debt metrics and a still challenging political environment. This constraint remains despite some easing on the political front in the last few months, with what DBRS considers as a more moderate stance on the potential path towards independence from the current Catalan government.

DBRS also views as a sign of normalisation the fact that Catalonia has taken back control over its finances following the appointment of a new regional government in May 2018. Recently, additional financing provided to the region in acknowledgement of some historical underfinancing as well as the authorisation from the national government for Catalonia to refinance part of its short-term debt with long-term loans are also positive developments.

The Stable trend on Catalonia’s ratings reflects DBRS’s view that the risks to the ratings are balanced. In particular (1) early indications that the political tensions in the region had affected some of Catalonia’s economic indicators are now fading; and (2) the fact that pro-independence parties kept their Parliamentary majority in the last regional elections, while it implies that uncertainty over the region’s political agenda is likely to remain, is counterbalanced by some indications of an improved dialogue between Catalonia and the national government.

RATING DRIVERS
Upward rating pressures could materialise if any or a combination of the following occur: (1) the political situation in Catalonia eases further and stabilises, with the regional government pursuing a significantly softer political agenda, reinforcing the region’s linkages with the national government; (2) the region reduces its indebtedness and improves its debt sustainability metrics markedly faster than currently foreseen.

Negative downward pressure on the ratings could materialise if any or a combination of the following materialise (1) the relationship between Catalonia and the national government materially worsens. In particular, indications that the current liquidity and financing support received by the region may be reduced would have negative credit implications; (2) there is a reversal in the region’s current fiscal consolidation path, leading to widening financing deficits compared with that recorded in 2017; or (3) there is material evidence of a significant and lingering economic slowdown in the region.

RATING RATIONALE

The Political Environment Remains a Key Rating Consideration

The political environment continues to weigh on Catalonia’s rating. While the pro-independence regional government somewhat softened its independence rhetoric —in part supported by the government change at the national level— DBRS considers that political uncertainty remains. In the current context of some former Catalan politicians in jail awaiting trial, a possible escalation of the conflict cannot be excluded.

As a result, in DBRS’s view, a potential worsening of the relationship between the national and regional governments remains a key rating consideration which continues to negatively affect DBRS’s assessment of the region’s political risk. On the positive side, DBRS points out that economic momentum in the region has remained strong despite early indications of slowing economic performance following the political tensions in the region.

Economic Growth Continues to Drive Fiscal Rebalancing

After years of poor financial results, Catalonia’s fiscal performance has substantially improved in 2016 and 2017. Its deficit stood at 0.56% of the region’s gross domestic product (GDP) in 2017, just below the target of 0.60% set by the national government, and substantially improved from the 2.83% deficit recorded in 2015. Catalonia’s fiscal consolidation was largely driven by the positive real GDP growth reported on average over the last 3 years in the region (3.7%) and the rest of Spain (3.3%). Marked GDP growth led to a pick-up in tax revenues — regional taxes and regional share of national taxes — which, coupled with continued control over regional expenditure, led to a rapid reduction in the headline deficit figures.

For 2018, DBRS expects fiscal consolidation to continue, although at a slower pace, on the back of still dynamic economic indicators. DBRS currently considers that the deficit target of 0.4% of GDP is within reach for the Catalan government. In line with still strong economic growth and tax collection, DBRS also views positively the continued increase in fiscal transfers from the national government towards Spanish regions in 2019. This increase should further support Catalonia’s fiscal consolidation, a positive credit feature.

Financing Provided by the National Government Critical to the Region’s Creditworthiness

The debt financing provided by the national government to its regions, the good conditions attached to it and DBRS’s expectation that this support will continue going forward are critical for Catalonia’s rating. The region’s large financing and refinancing needs have fully benefited from the national government’s support since 2012.

While Catalonia’s debt is very high at EUR 81.5 billion at the end of 2017 (278% of its operating revenues), DBRS gains comfort on its sustainability, given the national government’s support and very low funding costs from which the region currently benefits. DBRS also highlights that the regional debt-to-revenue ratio decreased in 2017 for the second consecutive year (from 305% in 2015), supported by lower financing needs and dynamic operating revenues. In its baseline scenario, DBRS anticipates that this positive trend would continue in 2018 and 2019.

RATING COMMITTEE SUMMARY

The DBRS European Sub-Sovereign Scorecard generates a result in the BBB (high) – BBB (low) range. Additional consideration factored into the Rating Committee decision included the uncertainty related to the political environment in the region and its potential impact on the region’s relationship with the national government as well as the regional economic prospects.

The main points discussed during the Rating Committee include: the relationship between the central government and the Autonomous Community of Catalonia, the political situation in the region, the region’s debt metrics and financial performance and Catalonia’s economic growth.

KEY INDICATORS FOR THE KINGDOM OF SPAIN

The following national key indicators were used for the sovereign rating. The Kingdom of Spain’s rating was an input to the credit analysis of the Autonomous Community of Catalonia.

Fiscal Balance (% GDP): -3.1 (2017); -2.7 (2018F); -2.3 (2019F)
Gross Debt (% GDP): 98.1 (2017); 97.4 (2018F); 96.0 (2019F)
Nominal GDP (EUR billions): 1,166 (2017); 1,209 (2018F); 1,256 (2019F)
GDP per Capita (EUR): 25,064 (2017); 25,887 (2018F); 2,6799 (2019F)
Real GDP growth (%): 3.0 (2017); 2.6 (2018F); 2.2 (2019F)
Consumer Price Inflation (%): 2.0 (2017); 1.8 (2018F); 1.7 (2019F)
Domestic Credit (% GDP): 208.1 (2016); 199.6 (2017); 197.5 (Mar-2018)
Current Account (% GDP): 1.8 (2017); 1.3 (2018F); 1.1 (2019F)
International Investment Position (% GDP): -85.3 (2016); -83.8 (2017); -82.6 (Jun-2018)
Gross External Debt (% GDP): 167.0 (2016); 166.6 (2017); 168.2 (Jun-2018)
Governance Indicator (percentile rank): 81.7 (2017)
Human Development Index: 0.89 (2017)

Notes:
All figures are in Euros (EUR) unless otherwise noted. Governance indicator represents an average percentile rank (0-100) from Rule of Law, Voice and Accountability and Government Effectiveness indicators (all World Bank). Human Development Index (UNDP) ranges from 0-1, with 1 representing a very high level of human development.

The principal applicable methodology is Rating European Sub-Sovereign Governments, which can be found on the DBRS website www.dbrs.com at http://www.dbrs.com/about/methodologies. The principal applicable rating policies are Commercial Paper and Short-Term Debt, and Short-Term and Long-Term Rating Relationships, which can be found on our website at http://www.dbrs.com/ratingPolicies/list/name/rating+scales.

The sources of information used for this rating include the Autonomous Community of Catalonia, Bank of Spain, Instituto Nacional de Estatística (INE). DBRS considers the information available to it for the purposes of providing this rating to be of satisfactory quality.

DBRS does not audit the information it receives in connection with the rating process, and it does not and cannot independently verify that information in every instance.

Generally, the conditions that lead to the assignment of a Negative or Positive Trend are resolved within a twelve month period. DBRS’s outlooks and ratings are under regular surveillance.

For further information on DBRS historical default rates published by the European Securities and Markets Authority (“ESMA”) in a central repository, see:
http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.

Ratings assigned by DBRS Ratings Limited are subject to EU and US regulations only.

Lead Analyst: Nicolas Fintzel, Vice President, Global Sovereign Ratings
Rating Committee Chair: Roger Lister, Managing Director, Chief Credit Officer, Global Financial Institutions and Sovereign Ratings Group
Initial Rating Date: 6 July 2018
Last Rating Date: 6 July 2018

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