S & P Raises Outlook On Spain--The Details

Spain, one of the most badly damaged economies in Europe got a break as S&P raised its outlook on the nation’s sovereign paper to “stable” from “negative. The debt will keep its ‘BBB-/A-3’ grade.

Spain has been particularly unlucky, perhaps more so than any nation in Europe other than Greece. Unemployment runs over 25%. Among young people, the figure is closer to 50%. Spain’s real estate market collapsed even harder than the one in the U.S. Many of its banks have been consolidated or dissolved. The move among the IMF, ECB, and EU has made it impossible for the country to raise money for stimulus packages.

The S&P announcement details:

RATING ACTION On Nov. 29, 2013, Standard & Poor’s Ratings Services revised its outlook on the Kingdom of Spain to stable from negative. At the same time, we affirmed our ‘BBB-/A-3’ long- and short-term foreign and local currency sovereign credit ratings on Spain.
RATIONALE Today’s rating action reflects our view that Spain’s external position is improving as economic growth gradually resumes. In addition, other credit metrics are stabilizing, in our view, due to budgetary and structural reforms, coupled with supportive eurozone policies.
Our assessment of the diversified and prosperous Spanish economy and the government’s financial, fiscal, and structural reform agenda support our ‘BBB-‘ long-term ratings on Spain. The ratings are constrained by our assessment of the high stocks of debt owed by Spain’s public and private sector to the rest of the world, as well as its generally low economic growth prospects over 2013-2016, and remaining inflexibilities, such as the still highly segmented labor market.
We estimate that Spain’s real GDP will contract by about 1.2% in 2013 but then slowly recover, following the prolonged recession due to the protracted structural adjustment in the Spanish economy. We forecast real GDP growth of 0.8% in 2014 and 1.2% in 2015, chiefly on the back of robust exports. Strong headwinds persist, however. Domestic demand is weak and constrained by further declines in disposable income due to high unemployment, reduced wages, and budgetary consolidation. In addition, investment activity remains subdued as the private sector deleverages its balance sheets and credit activity continues to decline. We currently project average annual real GDP growth over 2013-2016 of about 0.6%, compared with about 0.3% previously. Over the medium to long term, we think that, if left unchecked, high structural unemployment and unfavorable investment trends–compounded by demographic changes, including an aging population–will curb the economy’s growth potential.
We expect the current account surplus of about 1.4% of GDP in 2013 to rise to an estimated 3% of GDP in 2015-2016, after a deficit of almost 10% of GDP in 2008. We see improvement in this credit metric as key, as it points to a whittling down of Spain’s high external indebtedness. We estimate that if the surplus continues to grow in line with our current projections, the large net international liability position we estimated at about 94% of GDP in 2012 could decline to below 80% of GDP in 2016. The weak domestic demand and ensuing contraction in imports, plus the improved current account balance illustrate the economy’s reorientation toward external demand and strengthened competitiveness. According to the European Commission, Spain’s competitiveness index, based on unit labor costs relative to the rest of the eurozone, is already below its 2000 level. We consequently see restoration of price competitiveness based on this measure.
We think we would see even faster improvement in Spain’s external position and a speedier economic recovery if the private sector was not still burdened by high external borrowing costs. Meanwhile, these costs have markedly declined for the sovereign since mid-2012. We continue to see Spain’s monetary transmission mechanism as dysfunctional, despite the European Central Bank’s recent easing of its monetary policy. In our view, funding conditions for small and midsize enterprises are unlikely to improve markedly in the near term without specifically targeted additional monetary policy measures. We continue to regard credit risk in the economy as high, in part based on the still-rising amounts of nonperforming loans in the banking sector. Still, we currently do not expect the government to incur significant additional costs linked to banks’ recapitalization, beyond those financed by the €41.3 billion loan from the European Stability Mechanism.
We consider that the current recovery does not have a meaningful impact on the pace of budgetary consolidation, given that tax-rich components of economic growth–such as consumption–remain under pressure. We estimate the 2013 general government deficit at about 6.5% of GDP (excluding the cost of banking sector recapitalization, which we estimate at about 0.5% of GDP), in line with our previous expectations. We project that the government will broadly meet its budgetary deficit target of 5.8% of GDP in 2014, although possibly only after some additional fiscal effort.
The reduction in the budget deficit should accelerate in 2015 and 2016 based on the government’s announced plans, including reform of the public administration, and on the back of the cyclical recovery we forecast. However, we see significant implementation risks stemming from socioeconomic challenges and the upcoming 2015 general elections. As a result of the persistently high, albeit declining, budget deficits, we expect Spain’s net general government debt to increase to about 93% of GDP in 2016 from almost 83% of GDP in 2013, excluding the guarantees related to the European Financial Stability Facility (EFSF; see “S&P Clarifies Its Approach To Accounting For EFSF Liabilities When Rating The Sovereign Guarantors,” published on Nov. 2, 2011, on RatingsDirect). At the same time, average general government interest payments will likely represent about 9.3% of general government revenues during 2013-2016.
OUTLOOK The stable outlook incorporates our view that Spain’s credit metrics are stabilizing and that we currently see less than a one-in-three probability of the rating moving up or down over the next two years.
We could raise the ratings on Spain:

  • If the government continues implementing structural reforms that would improve the Spanish economy’s flexibility and growth potential;
  • If the budget deficit reduces further, in line with our current expectations, and general government debt metrics stabilize; and
  • If the external position continues to improve, bringing the narrow net external debt to below 150% of current account receipts or markedly easing the cost of or access to external financing for the private sector.
The ratings on Spain could come under renewed downward pressure:
  • If we believe the government is failing to implement additional structural reforms or if economic growth prospects falter;

  • If it appears to us that net general government debt will likely exceed 100% of GDP due to deviations from the government’s fiscal targets, weakening growth, potential deflationary pressures, and one-time items that push up debt (for example, the materialization of contingent liabilities), or if interest payments rise above 10% of general government revenues; or

  • If Spain’s current account weakens again or eurozone policies fail to keep investor confidence at a sufficient level to maintain sustainable government borrowing costs and to stem potential capital outflows.



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