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

DBRS Ratings GmbH (DBRS Morningstar) 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. The trend on all ratings is Stable.

KEY RATING CONSIDERATIONS
The Stable trend reflects DBRS Morningstar’s assessment that the risks to the ratings remain broadly balanced. As a reminder, DBRS Morningstar changed the trend on Catalonia’s ratings to Stable from Positive on 5 June 2020, to reflect the substantial shock from the Coronavirus Disease (COVID-19) pandemic on the Spanish and the regional economy. In 2020, Catalonia's finances have been affected by a combination of higher healthcare-related expenditure and lower tax collection. Nevertheless, the fiscal impact of the COVID-19 disease last year has been largely mitigated by the extraordinary transfers provided by the national government to all Spanish regions. In 2021, further extraordinary funding coupled with additional European funds should continue to support regional finances. DBRS Morningstar considers that Catalonia's financial performance is however likely to remain under pressure in 2022 and 2023, as the central government's budgetary support decreases.

Catalonia’s ratings remain underpinned by (1) the region’s robust economic indicators prior to the pandemic and its sound fiscal performance in recent years; and (2) the financing support provided by the Kingdom of Spain (A, Stable) to the regional government. While the political situation in the region remains a source of uncertainty, its impact on the regional economy or more generally on fiscal and financial management has thus far remained limited.

Catalonia’s Long-Term Issuer Rating currently remains at the BB (high) level given the region’s high debt metrics, the uncertainty regarding potential lasting effects from the COVID-19 pandemic on the regional economy and a still challenging political environment. Although DBRS Morningstar expects the region’s debt reduction to be a slow and lengthy process and the political noise over independence to remain over the long-term, the expected formation of a new regional government and gaining visibility around Catalonia's economic prospects will be key in the assessment of the region's credit profile in coming quarters

RATING DRIVERS
The ratings could be upgraded if: (1) the relationship between the region and the national government remains stable after the formation of a new regional government, 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; or (3) the Kingdom of Spain’s rating is upgraded.

The ratings could be downgraded if: (1) there is a material escalation of the political tensions between the region and the national government. Specifically, indications that the financing support received by the region may be reduced would have negative credit implications; or (2) there is a structural deterioration in the region’s fiscal performance, leading deficits to widen and placing debt metrics on a medium-term upward trajectory.

RATING RATIONALE

The COVID-19 outbreak has taken its toll on the Spanish and the regional economy in 2020

Catalonia and Spain more generally, have been severely affected by the pandemic. The latest figures available estimate that the regional gross domestic product (GDP) decreased by 11.4% in 2020, marginally worse than Spain's 11% decline. The large GDP decline largely reflected the extent of the healthcare crisis within the regional and national territories, the stringency of the lockdown that followed, and the higher concentration of economic activity in sectors severely affected such as tourism.

For 2021, economic forecasts remain clouded with uncertainty, given the risk related to the potential resurgence of infections with the apparition of new virus variants and the somewhat slow rollout of the vaccination process. While DBRS Morningstar views positively the improvement of the healthcare situation in Spain in recent weeks, the pickup in the economic recovery in coming quarters will be key to limit scarring effects of the virus on the regional and national economies. DBRS Morningstar's current moderate GDP growth scenario for Spain anticipates a rebound of 6.5% in 2021.

Despite the strength of the COVID-19 shock, the fiscal measures taken by the national government over the last 12 months as well as the resources expected from the Next Generation EU (NGEU, including the Recovery and Resilience Facility (RRF) as well as REACT-EU funds) from 2021, should help alleviate the long-term impact of the pandemic. DBRS Morningstar considers that the overall impact of the crisis on Catalonia will largely depend on how quickly economic activity resumes in coming months and quarters and on the ability of the region to absorb EU funds.

Following Regional Elections, the Political Environment Remains a Key Rating Consideration

On the political front, a new regional government is now expected to be formed in coming weeks, following the regional elections that took place in Catalonia on 14 February 2021. While the pro-independence parties slightly reinforced their majority in the regional parliament with 74 seats compared with 70 in the 2017 elections, and obtained a slim majority of the votes (51% of the total), this is counterbalanced, in DBRS Morningstar’s view, by (1) the strong results of the Socialist party (PSC-PSOE) which obtained the most votes with 23% of the total; and (2) the lead taken by Esquerra Republicana de Catalunya (ERC) among pro-independence parties, which presents a rhetoric on the independence question more oriented towards political dialogue.

While DBRS Morningstar expects the pro-independence question to remain at the top of the Catalan political agenda going forward, the tone of the discussions, if driven by ERC, should remain contained, with the less confrontational stance seen over the last 24 months to remain the key driver of the political interaction between the regional and the national governments. Further information on the election's results can be found in the following press release: DBRS Morningstar: Catalonia - COVID-19 Key Policy Focus For Now Even As Pro-Independence Parties Win Greater Parliamentary Representation.

The National Government’s Budgetary Support Mitigates So Far the Impact on Regional Finances

On the fiscal front, Catalonia’s fiscal performance marginally deteriorated in 2020, with a deficit-to-operating revenue ratio estimated at -6.5% compared with -3.6% in 2019. When considering the deficit-to-GDP, which includes some European System of Accounts (ESA) accounting adjustments, provisional figures for 2020 stand at around -0.4%, which would represent a marginal improvement compared to the -0.62% recorded in 2019. While final figures are still pending, DBRS Morningstar considers that the deterioration in Catalonia's financial performance is likely to have remained limited in 2020, reflecting the targeted budgetary support received from the national government. Spanish regions are responsible for healthcare and education expenditure in Spain. As a result, maintaining such financial support as long as necessary for economic activity to recover will be key to avoid substantial deterioration in regional finances going forward.

In 2021, the national government will continue to maintain a high level of transfers (entregas a cuenta) towards its regions. These transfers within the regional financing system will also be complemented by extraordinary transfers of EUR 13.5 billion, expected to assist regions in covering the additional costs related to the pandemic. In addition, European transfers related to the NGEU plan (estimated to represent EUR 15-20 billion in 2021) should allow regions to increase their capital expenditure throughout the year and possibly boost their economic recovery.

While the regional deficit is still expected to widen in 2021, with a reference rate for the deficit set at -1.1% of GDP for Spanish regions, overall, the fiscal focus for DBRS Morningstar will remain the years 2022 and 2023, likely to be affected by negative settlements under the regional financing system, as well as a decrease in the amount of extraordinary transfers provided by the national government. DBRS Morningstar continues to consider it likely that the national government will allow regions to repay any settlement over the long-term, as it did regarding the 2008 and 2009 negative settlements which are currently being repaid over 20 years. Nevertheless, addressing the share of new expenditure, particularly healthcare related, that is likely to remain structurally higher going forward will remain critical for regional finances to stabilise over the medium-term.

DBRS Morningstar will monitor (1) the level of transfers to regions; (2) the speed of absorption of EU funds; (3) the increase in the regions' structural expenditure; and (4) any potential additional measures taken by the national government to limit the future impact of the crisis on the regional finances..

The National Government’s Financing is Critical to the Region’s Creditworthiness
DBRS Morningstar expects Catalonia's financing needs to continue to be covered by the national government. Such financing remains critical for the region's credit ratings. Catalonia’s debt is very high, at close to EUR 82 billion at the end of 2020. This represents around 242% of the region's operating revenues, decreasing from 278% in 2019 due to the substantial increase in transfers received from the national government last year; or around 38% of the region's GDP compared with 35% in 2019. DBRS Morningstar gains comfort around the region's debt sustainability given the support it receives from the national government. The Spanish Treasury currently holds about 80% of the regional debt stock (Banco de España figure) and Catalonia has benefited from very low funding rates in recent years. While the improvement in the region's fiscal and debt metrics is now being challenged by the healthcare crisis, DBRS Morningstar continues to consider that Catalonia remains committed to strengthen its financial performance over the medium-term.

ESG CONSIDERATIONS

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/373262.

RATING COMMITTEE SUMMARY

The DBRS Morningstar European Sub-Sovereign Scorecard generates a result in the BBB (high) – BBB (low) range. Additional considerations factored into the Rating Committee decision included the remaining uncertainty related to the political environment in the region and its potential impact on the region’s relationship with the national government; the medium-term economic and fiscal risks related to the current pandemic.

The main points discussed during the Rating Committee include: the region’s economic growth in 2020 and the forecast for 2021; the impact of the COVID-19 pandemic on Catalonia’s fiscal and debt trajectories; the financial support provided by the national government during the pandemic; the political situation in the region and Catalonia’s relationship with the national government.

For more information on the Key Indicators used for the Kingdom of Spain, please see the Sovereign Scorecard Indicators and Building Block Assessments: https://www.dbrsmorningstar.com/research/374875.

The national scorecard 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.

Notes:
For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.

All figures are in euros (EUR) unless otherwise noted.

The principal methodology is the Methodology for Rating European Sub-Sovereign Governments (4 September 2020) https://www.dbrsmorningstar.com/research/366368/rating-european-sub-sovereign-governments. Other applicable methodologies include the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings https://www.dbrsmorningstar.com/research/373262/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings (February 3, 2021).

The sources of information used for this rating include the Autonomous Community of Catalonia for financial position and debt structure for the 2014-20 period, Bank of Spain for the debt metrics during the period between 2015 and Q3 2020, Independent Authority for Fiscal Responsibility (AIReF) for its quarterly estimate of the regional GDP growth (February 2021), Instituto Nacional de Estatística (INE), Ministry of Finance for the monthly budgetary execution. The 2020 European Social Progress Index from the European Commission was also used. DBRS Morningstar considers the information available to it for the purposes of providing this rating to be of satisfactory quality.

DBRS Morningstar 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 12-month period. DBRS Morningstar’s outlooks and ratings are under regular surveillance.

For further information on DBRS Morningstar 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. DBRS Morningstar understands further information on DBRS Morningstar historical default rates may be published by the Financial Conduct Authority (FCA) on its webpage: https://www.fca.org.uk/firms/credit-rating-agencies.

The sensitivity analysis of the relevant key rating assumptions can be found at: https://www.dbrsmorningstar.com/research/375245/.

This rating is endorsed by DBRS Ratings Limited for use in the United Kingdom.

Lead Analyst: Nicolas Fintzel, Senior Vice President, Global Sovereign Ratings
Rating Committee Chair: Thomas R. Torgerson; Managing Director, Co-Head of Global Sovereign Ratings
Initial Rating Date: July 6, 2018
Last Rating Date: September 11, 2020

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