Moody’s on Spanish regional debt

Because what the world needed, as Europe stumbles toward some kinds of resolution for Greece, was another Moody’s warning.

Today’s edition is on Spanish regional debt (we’ve highlighted the main bits):

In the absence of credible commitments by Spanish regions to take further steps to achieve sustainable improvements in their fiscal positions, we believe that the regions’ ratings will come under downward pressure. Our assessment is based on the following observations and expectations:

» We expect several Spanish regions to exceed the 2011 deficit target of 1.3% of GDP. This was confirmed by Catalunya’s recent 2011 budget plan, which foresees a deficit that is twice the size of the target. Similarly, the incoming new government in Castilla-La Mancha recently announced that the budget deficit and the commercial debt to suppliers (mainly in the healthcare sector) are much larger than previously assumed.

» Our expectation of fiscal slippage among Spanish regions is driven by their overly optimistic budgeted revenue forecasts; the difficulties they face in controlling rigid spending in healthcare and education; and the unwillingness among some regions to take fiscal consolidation measures prior to the May 2011 regional elections.

» If the regions do not implement new measures, we estimate that the overall regional deficit would deviate by an additional 0.75% of GDP from the initial target of 1.3%. Moreover, longstanding payment arrears in the healthcare sector and the need to alleviate liquidity tensions in the current funding environment have resulted in growing payables in many Spanish regions, which we view as credit-negative.

» Like last year, we expect the Moody’s-rated regions to fall into two groups: (i) the single- A-rated regions (Castilla La Mancha, Catalunya, Murcia and Valencia) that deviated widely from the deficit limit last year and are expected to again face significant difficulties in controlling their deficit in 2011; and (ii) the Aa-rated regions (Andalucia, Castilla y Leon, Extremadura, Galicia, Madrid and Basque country) that either complied with deficit targets last year or registered only a limited deviation from them, and are in a reasonable position to meet this year’s target. However, some in the latter group are also likely to face tighter liquidity positions and growing commercial debt, thus adding pressure to their ratings.

» Overall, we believe that there is a significant need to address the structural pressures on the regional budgets in a sustainable and systematic way through a greater reduction in the regions’ operating expenditure. In particular, we believe that securing a broad agreement across the political spectrum on issues such as healthcare spending are also important factors for maintaining the current ratings of Spain’s regional governments.

And of course, here’s what you’re really curious about — the potential impact on the sovereign rating:

The close credit linkages between the sovereign and sub-sovereign issuers in Spain implies that fiscal slippage at the sub-sovereign level has the potential to affect not just the ratings of Spanish regional governments but also that of the Kingdom of Spain. Our current rating on the Spanish government (Aa2 with a negative outlook) depends critically on the following factors:

(i) the achievement of the fiscal targets as set out by the government for itself, for the regional and local governments and for the social security system;

(ii) a successful reorganisation of the savings bank sector with limited financial impact on the sovereign’s balance sheet; and

(iii) continued market access at a reasonable cost.

Moody’s believes that the central government can probably accommodate some regional slippage by decreasing its own deficit more than the target – as it did last year. Budget execution data up until April 2011 indicate that the government is on track to achieve its own budgetary target for the year, with the deficit declining by 50% compared to the same period in 2010. The target for the year as a whole is 4.8% of GDP in cash terms, representing a reduction of 15.7% compared with 2010. However, the rise in funding costs that started in May last year will begin affecting the budget numbers in the coming months. We therefore do not expect progress to be quite as positive for the remainder of the year. The 0.75% slippage (or €8 billion versus €4.5 billion last year) that we currently anticipate at the regional government level equates to 7.6% of the central government revenues and 5% of government expenditure which may prove difficult to achieve without additional fiscal measures.

Therefore, in the absence of credible commitments by the regions to take the steps needed to achieve sustainable improvements in their fiscal positions, we believe the central government will find it very hard to achieve its overall fiscal targets. This is likely to exert further downward pressure not only on the ratings of the fiscally weak regions but also on the sovereign’s rating as it risks derailing the country’s fiscal consolidation plan.

Related links:
Meanwhile, in the Spanish periphery – FT Alphaville
Spain’s peripheral problems – €26.4bn of hidden debt? - FT Alphaville
Moody’s on Spain’s regional, retail shift - FT Alphaville