DBRS Confirms the Autonomous Community of Catalonia at BB (high), Trend Changed to Positive

DBRS Ratings GmbH (DBRS) confirmed the Long-Term Issuer Rating of the Autonomous Community of Catalonia (Catalonia) at BB (high) and its Short-Term Issuer Rating at R-4. At the same time DBRS changed the trend on all ratings to Positive from Stable.

KEY RATING CONSIDERATIONS

DBRS’s trend change to Positive from Stable on Catalonia’s BB (high) ratings reflects (1) the continued improvement in the region’s finances in 2018 and the expectation of further fiscal consolidation in 2019; (2) the positive track record on the economic and financial management fronts in spite of political tensions in the region and; (3) a political agenda pursued by the current regional government perceived as less confrontational towards the national government.

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. While DBRS continues to view the political situation in the region as a source of uncertainty, the rating agency considers that the impact of the political tensions between Catalonia and the national government on the regional economy or more generally on its fiscal and financial management have remained limited.

Catalonia’s Long-Term Issuer Rating currently remains at the BB (high) level given the region’s high debt metrics and a still challenging political environment. Although DBRS’s expects the region’s debt reduction to be a slow and lengthy process and the political noise to remain over the long-term, it considers that the region’s intrinsic performance has improved in the last 12 months and that key milestones are reachable for the region to strengthen its creditworthiness further in the next 12-18 months.

RATING DRIVERS

Triggers for an upgrade include: (1) the relationship between the region and the national government remains relatively stable with debt and fiscal management staying insulated from any potential rise in political tensions; (2) the region continues its fiscal consolidation towards a balanced budget position and improves its debt sustainability metrics further.

By contrast, a return to a Stable trend could stem from: (1) a material escalation of the political tensions between the region and the national government that would substantially worsen the relationship between both government tiers. Specifically, and although unlikely given the existing track record, indications that the financing support received by the region may be reduced would have negative credit implications; or (2) there is a deterioration in the region’s current fiscal consolidation path and decreasing debt-to-operating revenue figures.

RATING RATIONALE

The Political Environment Remains a Key Rating Consideration

Despite the trend change to positive from stable, the political environment continues to weigh on Catalonia’s rating. The pro-independence regional government has somewhat softened its independence rhetoric—in part supported by the government change at the national level in June 2018— but political uncertainty remains. The national elections scheduled for 28 April 2019 and the outcome of the trial of former Catalan politicians (“the trial”) expected later this year will be critical to assess how the political situation evolves.

Although DBRS does not exclude the possibility of an escalation of the conflict in the months ahead, its impact on Catalonia’s overall economic, fiscal and debt performance should remain limited. This assessment is supported by the sound regional track record since the peak of the political conflict in October 2017. DBRS highlights that the economic momentum in Catalonia remained strong throughout 2018.

In addition, the liquidity and financing support provided by the national government to the region remained unaffected. The application of the Article 155 of the Spanish Constitution (through which the national government placed the region and its finances under its administration and management), although it heightened political tensions, did not derail the region’s fiscal trajectory. Nevertheless, going forward, any material worsening of the relationship between the national and regional governments could prompt DBRS to revise its assessment of the region’s political risk; a key rating consideration for the region’s ratings.

Fiscal Consolidation Continues, Supported by Strong Economic Growth

On the fiscal side and in line with DBRS’s expectations, Catalonia’s fiscal performance has continued to improve in 2018. Its deficit for the year stood at -0.44% of the region’s gross domestic product (GDP), just above the target of -0.40% set by the national government, but substantially better than the -2.84% deficit recorded in 2015. Catalonia’s fiscal consolidation since 2015 was largely driven by the positive real GDP growth reported on average over the last four years in the region (3.4%) and the rest of Spain (3.1%). 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 2019, DBRS expects fiscal consolidation to continue, although at a slower pace, on the back of still dynamic albeit decelerating economic indicators. DBRS currently considers that the deficit target of -0.1% of GDP, although challenging, remains within the region’s reach. The positive fiscal trajectory should remain supported by the continued increase in fiscal transfers from the national government towards Spanish regions. Although the additional transfers (entregas a cuenta) remain conditional to the approval of the 2019 national budget (or the passage of a Royal decree) and hence the formation of a government after the general elections in April, DBRS anticipates that any delay in receiving these funds should remain temporary and therefore should not impact 2019 fiscal consolidation.

The National Government’s Financing is Critical to the Region’s Creditworthiness

The debt financing provided by the national government to its regions, the favorable 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 significantly benefited from the national government’s support since 2012.

DBRS also views positively the region’s recent shift in its key financing source from the Fondo de Liquidez Autonómico (FLA, a financing from the national government aimed at regions not complying with deficit and debt targets, based upon strong conditionality), to the Facilidad Financiera (which provides cheap financing to regions meeting targets without conditionality), which underpins the strengthening of the region’s fiscal performance in recent years.

While Catalonia’s debt is very high at EUR 82.1 billion at the end of 2018 (291% of its operating revenues), DBRS gains comfort on its sustainability, given the national government’s support (more than 70% of the regional debt stock) and the very low funding costs from which the region currently benefits. DBRS also highlights that the regional debt-to-revenue ratio decreased in 2018 for the third consecutive year (from 334% in 2015), supported by lower financing needs and dynamic operating revenues. In its baseline scenario, DBRS continues to anticipate that this positive trend would continue in 2019 and 2020.

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 region’s medium-to-long-term economic prospects.

The main points discussed during the Rating Committee include: the relationship between the national government and the Autonomous Community of Catalonia and the political situation in the region and in the country. In addition, the region’s debt trajectory, fiscal consolidation and economic growth were discussed.

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 (2018E); -2.5 (2019F)
Gross Debt (% GDP): 98.1 (2017); 96.9 (2018E); 96.0 (2019F)
Nominal GDP (EUR billions): 1,166.3 (2017); 1,206.9 (2018); 1,259.2 (2019F)
GDP per Capita (EUR): 25,064.4 (2017); 25,824.9 (2018E); 26,871.1 (2019F)
Real GDP growth (%): 3.0 (2017); 2.5 (2018); 2.2 (2019F)
Consumer Price Inflation (%): 2.0 (2017); 1.7 (2018); 1.7 (2019F)
Domestic Credit (% GDP): 207.9 (2016); 199.4 (2017); 194.9 (Sep-2018)
Current Account (% GDP): 1.8 (2017); 0.8 (2018); 0.8 (2019F)
International Investment Position (% GDP): -85.3 (2016); -83.8 (2017); -80.7 (Sep-2018)
Gross External Debt (% GDP): 167.0 (2016); 166.6 (2017); 167.5 (Sep-2018)
Governance Indicator (percentile rank): 81.7 (2017)
Human Development Index: 0.89 (2017)

Notes:
All figures are in euros (EUR) unless otherwise noted. Public finance statistics reported on a general government basis unless specified. Fiscal balance (IGAE/INE/EC/BdE), Gross debt (BdE/INE/EC/DBRS), Nominal GDP (INE/EC), GDP per Capita (BdE/INE/EC), Real GDP Growth (INE/EC), Consumer Price Inflation (INE/EC), Domestic Credit (BdE/INE), Current Account (BdE/INE/DBRS), International Investment Position (BdE/INE), Gross External Debt (BdE/INE). 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, Independent Authority for Fiscal Responsibility (AIReF), 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 GmbH 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
Initial Rating Date: 6 July 2018
Last Rating Date: 5 October 2018

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