Axesor Rating reviews the credit rating of the Community of Madrid to A- with negative outlook due to the post-COVID-19 budget gap and the seasonal nature of employment

13th July of 2020

Unsolicited rating of the Community of Madrid

Axesor Rating has reviewed Madrid’s credit rating of A- with change of outlook to negative due to the impact that the health crisis will have on regional finances. Accordingly, a contraction of GDP in line with Spain’s (10.8%) and a significant increase in the unemployment rate caused by the high rate of temporary employment in the region are expected. On the positive side, the process of fiscal consolidation in recent years stands out, after having met the deficit target and a level of debt on GDP within the limits that the Budget Stability Law sets.

The review of the unsolicited credit rating of A- with an outlook from Stable to Negative for the Community of Madrid reflects the effect that the economic shock caused by COVID-19 will have on regional accounts. Accordingly, the regional GDP is expected to contract by around 10.8% and the unemployment rate is predicted to increase significantly due to the high seasonality of employment in the region. Foremost among its strengths are the fiscal consolidation process of the last few years and the economic dynamism of the region, which has increased its level of resilience against the crisis.

Madrid, Monday, July 13, 2020

Axesor Rating reports the review of the unsolicited credit rating of the City of Madrid of A- with Negative outlook. It is done as a continuation of the recent review of the Kingdom of Spain (A/Under Observation) and based on the uncertain scenario after the COVID-19 health crisis from which a structural economic impact could arise due to the confinement of the population and the disruption of economic activity during March and April.

Negative growth and increase in the unemployment rate

The unsolicited credit rating of A- with an outlook from Stable to Negative is reasoned on the foreseeable depth that the economic shock caused by the pandemic will have in the region, one of the most affected. At Axesor Rating we expect GDP to contract in line with what Spain as a whole will do (10.8%) and the unemployment rate to behave similarly, with a remarkable increase caused by the high seasonality of employment in the region, especially among the younger population.

However, the resilience and dynamism of the regional economy in recent years stands out, with growth of 3% last year (more than one point above the Spanish average of 1.9%). Also, the Community of Madrid is the region that concentrated the bulk of foreign investments received at the national level, namely 13,703 million euros, ahead of Catalonia.

Moreover, the rating positively assesses the advances made in the fiscal consolidation process in recent years, having met the fiscal deficit target (0.1%) and the spending rule. Also, its level of debt on GDP stood at 14%, just two tenths above the limits set by the Budget Stability Law (13.8%). However, after the health crisis, a rise in expenditure and a drop in revenue are expected, which could impair the financial situation in the region.

Over-reliance on the services industry

The report considers the severity of the effects that the health crisis has had on the economy of Madrid. The severity of the social distancing measures taken on supply and demand during the first quarter of the year have led to a contraction in GDP of 2.30%, nearly three points less than the one Spain recorded during the same period (5.2%). Nevertheless, this percentage only includes data until March, that is to say, only the first two weeks of confinement and it is therefore expected that the evolution during the second quarter of the year will be more contractionary.

In the same way, 80% of this drop is explained by excessive tertiarization of the regional economy, in which hospitality industry and trade underpin much of the productive activity. Also noteworthy is the contraction of -4.9% quarter-on-quarter in the construction sector as well as the registration of vehicles during March and April, which plummeted to unprecedented lows.

Given this scenario, the labor market has suffered the worst consequences. During the first quarter of 2020, unemployment in the region increased by 52,000 people, reaching an unemployment rate of 10.66%, which does not include the more than half a million workers affected by temporary layoffs (16.4 % of the national total). This increase is due to the high rate of seasonality, which in the Community of Madrid stands at 20.14%. Thus, looking ahead to the end of the year, estimates show a drop in employment growth of 5.2%.

However, the rating highly assesses the fact that Madrid still remains among the regions with the highest labor activity and the favorable performance of its economy prior to the health crisis, which we hope will be a determining factor in regaining the confidence of consumers, businesses and economics operators.

Falling revenues and increased expenses

The Community of Madrid presented for the year 2020 a carried over budget from the previous year which contemplates a total of 23,308 million euros in revenue, with direct taxes (income tax) as main source of finance (54.5%).

From the expenditure side, regional accounts bear the amount of 23,333 million euros, updated to pay the debt and always within the framework of the Budget Stability and Financial Sustainability Law. While financial expenses increased slightly (+ 0.31%) to 766 million euros, the financial expenditure per capita was reduced to 113 euros. At the same time, investment expenditure remained at 3.45% of current revenue.

However, the health crisis has changed all estimations and the regional government itself forecasts an impact of 1,260 million euros on the accounts until the end of May (974 associated with the increase in expenditure and 286 with the reduction in revenue). From now to the end of the year, impact forecasts amount to 2,797 million euros (13.4% of the current budget).

Based on this, at Axesor Rating we expect a possible financial imbalance during 2020 due to both the fall in revenue from lower tax collection and the increased expenditure required to address the health crisis. In this regard, we believe that the region could see a decline in gross savings figures, leaving behind the situation of non-financial surplus of 327 million euros (0.13% of regional GDP) to give way for a new deficit (Breaking the trend observed since 2017).

Though the above is the main limitation of the granted credit rating, it assesses very positively the process of fiscal consolidation of regional accounts. The Community of Madrid has met the deficit target of 0.1%, as well as the spending rule. In terms of debt on GDP, it stood at 14% (31,524 million euros), just two tenths above the target of 13.8% set by the Budget Stability and Financial Sustainability Law. In addition, its average life has been improved to 7.6 years and its average cost has been reduced to 2.19%.

In spite of this good starting position after the outbreak of the health crisis a quarterly increase in debt of nearly 600 million euros has been noticed, up to 34,052 million euros, a figure which is expected to increase until the end of the year.

Government and ESG

The A- credit rating takes into account the correct institutional framework that sets the operation of the Community of Madrid, integrated into the set of regions belonging to the so-called common system financing system and that are required to comply with the Budget Stability and Financial Sustainability Law. It should be pointed out that it has a comparatively lower degree of self-government and autonomy than that of the foral regime, which has sometimes made it difficult to cover financial obligations.

In fact, Madrid is one of the communities with the lowest levels of per capita funding in Spain, being a mainly contributing region, so any reform of the autonomous financing system that is designed to provide greater fiscal autonomy to the regions will positively affect it, given the high per capita income of its citizens.

On the other hand, the PP - Ciudadanos coalition government is positively assessed: though ruling in minority, it has overcome political tensions and has managed to approve a Plan for the Reactivation as a first step to reverse the effects caused by the health crisis.

On the side of ESG principles, the Community of Madrid, which has issued sustainable bonds since 2016, continues to be one of the most active. Last April, Madrid was the first autonomous community to issue a green bond, worth 700 million euros to be allocated to implement environmental measures.

Also, because of the existing health crisis, the regional government has implemented measures to ensure safety, containment, and control of the virus, including the issuance of a Social Health Bonus of 52 million euros, first among regional governments.

All the above is reinforced by a fiscal policy and environmental and social legislation according to the abovementioned environmental, social, and responsible principles.