In its September review, EthiFinance Ratings maintains the unsolicited rating of the Kingdom of Spain at A- with an Under-observation outlook. Despite the situation of uncertainty that economies are facing, the rating assesses both the positive growth that has been observed in 2021 and that has had continuity in the first two quarters of the year, and the impact of the Next Generation Funds, whose investments shall aim mainly to sectors of the productive economy with high added value (technology and industry, among others), the recovery of tourism activity, with an annual increase in tourism expenditure of 271.3%, and the dynamism of the labor market.
However, the European rating agency has revised downwards Spain's growth forecasts to 4.3% for this year 2022, a figure which is 1.2 points lower than that estimated in last March's rating, and to 1.9% for 2023 due to the “sustained increase in uncertainty and inflationary pressures, whose impact on consumption and production will be greater than initially estimated.”
In this respect, the report highlights the effect of restrictions on the supply of raw materials and certain foods, mainly stemming from the conflict between Russia and Ukraine. This has led to an increase in prices “which, eventually, has been transferred to other goods and services.” In this sense, the report points to the risk posed to the economy by the rise of core inflation to 6.4% last August. "In addition, the rise in prices is having an impact on all the countries of the European Union (EU) similarly, so we estimate that it will weigh on domestic and external demand, as well as on production", the rating report states.
In this sense, EthiFinance Ratings expects annual inflation to rise to 8.3% at year-end despite the “slight” normalization of prices at the end of the year. In addition to the statistical effect, the gas price cap, and the moderation of the oil price, this normalization will come about by the tightening of the monetary policy of the European Central Bank in response to the constant rise in inflation. At this point, it should be noted that, as the report warns, the new interest rate rises scheduled for the end of the year will limit consumption in the last quarter of 2022 and the first quarter of 2023, which in turn will slow down economic growth.
The rating assesses the “positive”evolution of employment, favored by the labor reform approved last March, which has boosted permanent. In this respect, the unemployment rate will decrease to 13.6 % of the working population in 2022 and to 13.1 % in 2023. Nevertheless, as it has been noted in previous reports, Spain maintains high rates of unemployment and dependency, which, together with low population growth, represent "one of the main limitations of our rating, in addition to posing a future risk to the sustainability of public finance". A fact, the latter, which would be aggravated by the indexation to the CPI of pensions -contained in the latest reform of the system- and the increase in prices estimated for the next biennium.
Foreign sector: deterioration of the current account balance
The credit rating report of the Kingdom of Spain makes special mention of the foreign sector which, although it will continue to be one of the pillars of the Spanish economy, is being affected by the general increase in prices and, especially, the deterioration of the energy deficit, "being the increase in exports of services due to tourism insufficient to offset the increase in imports," the report points out. Thus, even though the surplus situation will remain, it will be cut to 0.5% of GDP in 2022 and normalized in 2023, when a four-tenths increase is forecast to 0.9%.
The rating is, in turn, constrained by a record high volume of gross external debt, to 193.3% of GDP, which poses a risk given the tightening of financing conditions and the depreciation of the euro in recent months. Despite this, this debt would be more isolated from exogenous shocks because the main part was established in the long term, with a fixed interest rate and denominated in euros.
In terms of fiscal positions, the rating positively assesses the fiscal consolidation process conducted by the Spanish Government in recent years. With a gradual improvement in government deficit and debt levels. Even so, these “remain at high levels.”
Concerning the deficit, the year will end with a negative rate of -5%, according to the forecasts of EthiFinance Ratings. Despite the increase of 1.6 points in current expenditure to 2.4% (-0.9% in the March revision), this figure is contained by the higher expected tax collection due to the rise in prices.
Meanwhile, public debt will stand at 116.3% of GDP at the end of the financial year. Levels on which "no significant reduction of this debt is expected in the coming years". Moreover, the potential risk implied by the rise in interest rates is offset by the contraction of the interest ratio on current income, due to the aforementioned increase in collection, as well as by the increase in the maturity period, up to an average of eight years.
Finally, the rating highlights the improvement in Spain's liquidity profile compared to last March's review, with liquid financial assets of 14.8% of GDP and 14.1% in 2022 and 2023, respectively, according to the IMF.
The report also mentions the situation of the Spanish financial system, which has managed to contain the increase in the NPL ratio. In fact, according to data from the first half of the year, most of the major Spanish banks have reported a decrease. At this point, the elevated level of debt on GDP and the low profitability of the financial sector (which is expected to improve with the rise in interest rates) limit the rating.
ESG and institutional framework
EthiFinance Ratings positively assesses the advances made by Spain in the area of ESG (Environmental, Social, and Governance) in recent years, including the first issue of sovereign bonds worth EUR 5 billion. Also, the conditions for receiving European Funds include that a substantial proportion is allocated to green investments, “which must guarantee a favorable evolution in the country’s environmental commitment”.
However, there are “certain downward biases,” such as non-compliance with some EU environmental laws and the fact that the country is one of the most exposed to climate change within the EU. Moreover, Spain is the Member State with the highest number of open cases for infringement of environmental laws in the EU, with a total of twenty-six. Likewise, the Global Climate Risk Index 2021 — which measures a country's vulnerability to climate change — indicates that Spain ranks 32nd among all countries in the world.
Furthermore, Spain has an elevated level of energy dependence, with net energy imports accounting for 67% of total energy consumption, only behind Italy (73%). Despite this, the rating values the high decarbonized electricity mix in Spain, where 42% of electricity comes from renewable energies.
On a social level, the European rating agency positively assesses the Spanish welfare state, which grants a series of social guarantees to the entire population. However, the report highlights the increase in inequality between Spain and the rest of the countries of the European Union, due to the increased impact of COVID-19.>
Concerning the institutional framework, although it is generally assessed positively for its solidity, the report warns of factors such as political decentralization that may affect the country’s evolution in the medium term, since they “reduce efficiency and agility in public policies”. At this point, it is expected that the fact that much of the investments of the Recovery Plan Transformation and Resilience are channeled at the regional level "does not represent a burden for the effectiveness of its implementation".
In addition, the increasing fragmentation of the parliament "could make it difficult to approve reforms necessary to meet the requirements of the different disbursements of the NGEU funds".