A resilient economic recovery and a reduction of economic, fiscal and external imbalances support the rating; high public and external debt, elevated unemployment, limited structural fiscal adjustment, and political fragmentation are constraints.
Scope Ratings GmbH has today affirmed Spain’s A- long-term issuer and senior unsecured local- and foreign-currency ratings, along with a short-term issuer rating of S-1 in both local and foreign currency. All Outlooks are Stable.
The A- rating is supported by Spain’s euro area membership, the size and diversity of its economy, robust economic recovery, and on-going reduction of economic, fiscal and external imbalances, particularly its significant private-sector deleveraging. Persistently high public and external debt levels, elevated structural unemployment, low productivity growth, and limited structural fiscal adjustment pose challenges. The Stable Outlook reflects Scope’s view that the upside potential from a continued reduction in economic, fiscal and external imbalances is balanced by the downside risk stemming from a politically fragmented environment, which is limiting the government’s capacity to implement reforms to increase Spain’s growth potential and make structural fiscal adjustments.
Since 2014 the Spanish economy has grown, on average, around 2.8%, a full percentage point above the euro area average, driven by i) the government’s structural reforms, which, except for the insolvency framework and ongoing banking sector reforms, were mostly implemented from 2010-2015, ii) wage moderation and resulting cost-competitiveness gains, iii) low oil prices, iv) the European Central Bank’s accommodative monetary policy, and v) the favourable external conditions, particularly in the euro area. In addition, the structural adjustment in the economy has resulted in a shift in resources towards the dynamic, export-oriented services sector. As a result, Scope expects Spain’s balanced and employment-intensive economic expansion to continue over the next few years, albeit with less dynamism, moderating economic growth from the 2017 growth level of 3.1% to around 2.5% over the medium term.
Scope also notes that the increase in confidence, employment and economic stability has led to the resumption of investment and private consumption despite a marked decline in private sector liabilities, which further supports the A- rating. Since the crisis, the Spanish private sector has significantly reduced its indebtedness to levels similar to those of its euro area peers. Specifically, non-financial corporates have reduced their liabilities by EUR 306.5bn since Q2 2010. In turn, households reduced their liabilities more gradually given that most loans are long-term mortgages, but still by EUR 202.6bn over the same period. As a result, corporate sector indebtedness fell from 133.1% of GDP to 96.8% as of Q4 2017, slightly below the euro area average of 101.7%, while household indebtedness decreased from around 85.1% to 61.3%, just above the euro area average of 58.0%.
Spain’s A- rating is further supported by the gradual fiscal consolidation. Spain has successfully reduced its fiscal balances every year since 2012, with the general government balance dropping successively from 10.5% in 2012 to 3.1% last year. Scope notes that Spain’s fiscal consolidation took place at all layers of government between 2012 and 2017, with the fiscal balance falling by about 6pp at the central government level, from around negative 7.9% of GDP to negative 1.9%. Regional governments also reduced their fiscal balances, on average, to a deficit of negative 0.3% last year, better than the target of negative 0.6% but with wide dispersion among the regions. Finally, the higher deficit of the social security system (negative 1.5% in 2017), which has been in deficit every year since 2010, was partly compensated by the 0.6% surplus of local governments. Going forward, although a 2018 budget has not yet been adopted and is likely to be slightly expansionary if implemented, Scope expects Spain to exit the EU’s excessive deficit procedure this year, recording deficits well below the 3% Maastricht criterion.
Despite this gradual fiscal adjustment, Spain’s public debt level has remained relatively stable since 2014 at slightly below 100% of GDP and below the levels of Portugal (126%) and Italy (132%), but significantly above the 60% Maastricht criterion, which, in Scope’s opinion, constitutes a major rating constraint. Scope’s public debt sustainability analysis, based on IMF forecasts and a combination of growth, interest-rate and primary-balance shocks, confirms that slower growth and primary balances remain the key risks to Spain’s debt sustainability. Scope’s baseline scenario is for the debt-to-GDP ratio to fall modestly to around 90% by 2023, which highlights the need for Spain to maintain relatively high growth rates as well as sustain a significant level of fiscal consolidation over a multi-year period.
In this context, Scope notes that while the short-to-medium-term growth outlook is robust, Spain’s long-term economic growth prospects face considerable challenges, with potential economic growth estimated between 1.7% (IMF) and 2.1% (European Commission). This lower economic growth outlook is due to weak productivity growth, unfavourable labour force demographics, and high structural unemployment. In fact, Scope identifies Spain’s structural unemployment, the highest among euro area members, as an enduring macro-economic imbalance. In Scope’s opinion, widespread use of temporary contracts, an elevated youth unemployment rate that is still more than double the national average, and the long-term unemployed, who account for almost half of all unemployed persons, is not only likely to limit Spain’s growth potential over the medium term, it also increases the risk of sustained income inequality, poverty and social exclusion among vulnerable groups.
Scope also notes that the fiscal adjustment to date, while credit-positive, has been mostly cyclical, benefiting from improving labour market conditions and reduced interest expenditure. In fact, Spain’s cyclically adjusted primary balance turned negative in 2016, and is expected to remain in deficit during the coming years, suggesting a mildly expansionary structural fiscal stance. As a result, based on European Commission data, Spain’s structural fiscal deficit of around 3% for the 2017-2019 period, the highest among all euro area member states and well above the medium-term objective of a structural balance by 2020 under European and national rules, limits the government’s debt reduction and thus the potential rating upside.
Finally, Scope believes that the current political fragmentation, and the resulting weak minority government led by the Partido Popular with 134 of 350 seats in the Congress of Deputies, is significantly constrained in formulating and implementing a comprehensive reform agenda to: i) raise Spain’s growth potential and ii) increase the structural fiscal adjustment needed to reduce the country’s public debt level. It is Scope’s opinion that Spain’s overall political standstill, due in part to the unresolved situation in Catalonia, could lead to national elections prior to the scheduled end of this legislature’s term, which is set for June 2020.
Core Variable Scorecard (CVS) and Qualitative Scorecard (QS)
Scope’s Core Variable Scorecard (CVS), which is based on the relative rankings of key sovereign credit fundamentals, provides an indicative “BBB” (“bbb”) rating range for the Kingdom of Spain. This indicative rating range can be adjusted by the Qualitative Scorecard (QS) by up to three notches depending on the size of relative credit strengths or weaknesses versus peers based on qualitative analysis. For the Kingdom of Spain, the following relative credit strengths have been identified: i) economic policy framework, ii) fiscal policy framework, iii) market access and funding sources, iv) current-account vulnerability, v) external debt sustainability, vi) vulnerability to short-term external shocks, vii) banking sector performance, and viii) banking sector oversight and governance. Relative credit weaknesses are: i) recent events and policy decisions. The combined relative credit strengths and weaknesses generate a two-notch adjustment and indicate a sovereign rating of A- for the Kingdom of Spain. A rating committee has discussed and confirmed these results.
For further details, please see Appendix 2 of the rating report.
Outlook and rating-change drivers
The Stable Outlook reflects Scope’s view that the upside potential of a continued reduction in economic, fiscal and external imbalances is balanced by the downside risk stemming from a politically fragmented environment, which is limiting the government’s capacity to implement reforms to increase Spain’s growth potential and make structural fiscal adjustments.
The rating could be upgraded if the sovereign: i) achieves sustained debt reduction, ii) implements additional reforms, raising the country’s medium-term growth potential, and iii) improves its external balance sheet. Conversely, the rating could be downgraded if: i) public finances deteriorate due to a reversal of fiscal consolidation and ii) there is a fading commitment to or a reversal of structural reforms, leading to an adverse impact on the medium-term economic and fiscal outlook.
The main points discussed by the rating committee were: i) Spain’s growth potential, ii) macroeconomic stability and sustainability, iii) fiscal consolidation, outlook, and public debt sustainability, iv) external debt sustainability and vulnerability to shocks, v) banking sector performance and private sector deleveraging, vi) political fragmentation, and vii) peers.
Oil extends losses as Texas prepares to ramp up output
By Ahmad Ghaddar
LONDON (Reuters) – Oil prices fell from recent highs for a second day on Friday as Texas energy firms began to prepare for restarting oil and gas fields shuttered by freezing weather.
Brent crude futures were down $1.16, or 1.8%, to $62.77 per barrel, by 1150 GMT, while U.S. West Texas Intermediate (WTI) crude futures fell $1.42, or 2.4%, to $59.10 a barrel.
Unusually cold weather in Texas and the Plains states curtailed up to 4 million barrels per day (bpd) of crude oil production and 21 billion cubic feet of natural gas, according to analysts.
Texas refiners halted about a fifth of the nation’s oil processing amid power outages and severe cold.
However, firms in the region on Friday were expected to prepare for production restarts as electric power and water services slowly resume, sources said.
“The market was ripe for a correction and signs of the power and overall energy situation starting to normalise in Texas provided the necessary trigger,” said Vandana Hari, energy analyst at Vanda Insights.
Oil fell despite a surprise fall in U.S. crude stockpiles in the week to Feb. 12, before the freeze. Inventories fell by 7.3 million barrels to 461.8 million barrels, their lowest since March, the Energy Information Administration reported on Thursday. [EIA/S]
The United States on Thursday said it was ready to talk to Iran about both nations returning to a 2015 agreement that aimed to prevent Tehran from acquiring nuclear weapons.
While the thawing relations could raise the prospect of reversing sanctions imposed by the previous U.S. administration, analysts did not expect Iranian oil sanctions to be lifted anytime soon.
“This breakthrough increases the probability that we may see Iran returning to the oil market soon, although there is much to be discussed and a new deal will not be a carbon-copy of the 2015 nuclear deal,” StoneX analyst Kevin Solomon said.
(Additional reporting by Roslan Khasawneh in Singapore and Sonali Paul in Melbourne; editing by Jason Neely)
Analysis: Carmakers wake up to new pecking order as chip crunch intensifies
By Douglas Busvine and Christoph Steitz
BERLIN (Reuters) – The semiconductor crunch that has battered the auto sector leaves carmakers with a stark choice: pay up, stock up or risk getting stuck on the sidelines as chipmakers focus on more lucrative business elsewhere.
Car manufacturers including Volkswagen, Ford and General Motors have cut output as the chip market was swept clean by makers of consumer electronics such as smartphones – the chip industry’s preferred customers because they buy more advanced, higher-margin chips.
The semiconductor shortage – over $800 worth of silicon is packed into a modern electric vehicle – has exposed the disconnect between an auto industry spoilt by decades of just-in-time deliveries and an electronics industry supply chain it can no longer bend to its will.
“The car sector has been used to the fact that the whole supply chain is centred around cars,” said McKinsey partner Ondrej Burkacky. “What has been overlooked is that semiconductor makers actually do have an alternative.”
Automakers are responding to the shortage by lobbying governments to subsidize the construction of more chip-making capacity.
In Germany, Volkswagen has pointed the finger at suppliers, saying it gave them timely warning last April – when much global car production was idled due to the coronavirus pandemic – that it expected demand to recover strongly in the second half of the year.
That complaint by the world’s No.2 volume carmaker cuts little ice with chipmakers, who say the auto industry is both quick to cancel orders in a slump and to demand investment in new production in a recovery.
“Last year we had to furlough staff and bear the cost of carrying idle capacity,” said a source at one European semiconductor maker, who spoke on condition of anonymity.
“If the carmakers are asking us to invest in new capacity, can they please tell us who will pay for that idle capacity in the next downturn?”
The auto industry spends around $40 billion a year on chips – about a tenth of the global market. By comparison, Apple spends more on chips just to make its iPhones, Mirabaud tech analyst Neil Campling reckons.
Moreover, the chips used in cars tend to be basic products such as micro controllers made under contract at older foundries – hardly the leading-edge production technology in which chipmakers would be willing to invest.
“The suppliers are saying: ‘If we continue to produce this stuff there is nowhere else for it to go. Sony isn’t going to use it for a Playstation 5 or Apple for its next iPhone’,” said Asif Anwar at Strategy Analytics.
Chipmakers were surprised by the panicked reaction of the German car industry, which persuaded Economy Minister Peter Altmaier to write a letter in January to his counterpart in Taiwan to ask its semiconductor makers to supply more chips.
No extra supplies were forthcoming, with one German industry source joking that the Americans stood a better chance of getting more chips from Taiwan because they could at least park an aircraft carrier off the coast – referring to the ability of the United States to project power in Asia.
Closer to home, a source at another European chipmaker expressed disbelief at the poor understanding at one carmaker of how it operates.
“We got a call from one auto maker that was desperate for supply. They said: Why don’t you run a night shift to increase production?” this person said.
“What they didn’t understand is that we have been running a night shift since the beginning.”
NO QUICK FIX
While Infineon, the leading supplier of chips to the global auto industry, and Robert Bosch, the top ‘Tier 1’ parts supplier, both plan to commission new chip plants this year, there is little chance of supply shortages easing soon.
Specialist chipmakers like Infineon outsource some production of automotive chips to contract manufacturers led by Taiwan Semiconductor Manufacturing Co Ltd (TSMC), but the Asian foundries are currently prioritising high-end electronics makers as they come up against capacity constraints.
Over the longer term, the relationship between chip makers and the car industry will become closer as electric vehicles are more widely adopted and features such as assisted and autonomous driving develop, requiring more advanced chips.
But, in the short term, there is no quick fix for the lack of chip supply: IHS Markit estimates that the time it takes to deliver a microcontroller has doubled to 26 weeks and shortages will only bottom out in March.
That puts the production of 1 million light vehicles at risk in the first quarter, says IHS Markit. European chip industry executives and analysts agree that supply will not catch up with demand until later in the year.
Chip shortages are having a “snowball effect” as auto makers idle some capacity to prioritize building profitable models, said Anwar at Strategy Analytics, who forecasts a drop in car production in Europe and North America of 5%-10% in 2021.
The head of Franco-Italian chipmaker STMicroelectronics, Jean-Marc Chery, forecasts capacity constraints will affect carmakers until mid-year.
“Up to the end of the second quarter, the industry will have to manage at the lean inventory level,” Chery told a recent Goldman Sachs conference.
(Douglas Busvine from Berlin and Christoph Steitz from Frankfurt; Additional reporting by Mathieu Rosemain and Gilles Gillaume in Paris; Editing by Susan Fenton)
Aussie and sterling hit multi-year highs on recovery bets
By Tommy Wilkes
LONDON (Reuters) – The Australian dollar rose to near a three-year high and the British pound scaled $1.40 for the first time since 2018 on optimism about economic rebounds in the two countries and after the U.S. dollar was knocked by disappointing jobs data.
The U.S. currency had been rising in recent days as a jump in Treasury yields on the back of the so-called reflation trade drew investors. But an unexpected increase in U.S. weekly jobless claims soured the economic outlook and sent the dollar lower overnight.
On Friday it traded down 0.3% against a basket of currencies, with the dollar index at 90.309.
The Aussie rose 0.8% to $0.784, its highest since March 2018. The currency, which is closely linked to commodity prices and the outlook for global growth, has been helped by a recent rally in commodity prices.
The New Zealand dollar also gained, and was not far off a more than two-year high, while the Canadian dollar rose too.
Sterling rose to $1.4009 on Friday, an almost three-year high amid Britain’s aggressive vaccination programme.
Given the size of Britain’s vital services sector, analysts say the faster it can reopen the economy, the better for the currency. Sterling was also helped by better-than-expected purchasing managers index flash survey data for February.
The U.S. dollar has been weighed down by a string of soft labour data, even as other indicators have shown resilience, and as President Joe Biden’s pandemic relief efforts take shape, including a proposed $1.9 trillion spending package.
Despite the recent rise in U.S. yields, many analysts think they won’t climb too much higher, limiting the benefit for the dollar.
“Our view remains that the Fed will hold the line and remain very cautious about tapering asset purchases. We think it will keep communicating that tightening is very far off, which should dampen pro-dollar sentiment,” said UBS Global Wealth Management strategist Gaétan Peroux and analyst Tilmann Kolb.
ING analysts said “the rise in rates will be self-regulating, meaning the dollar need not correct too much higher”.
They see the greenback index trading down to the 90.10 to 91.05 range.
The euro rose 0.4% to $1.2134. The single currency showed little reaction to purchasing manager index data, which showed a slowdown in business activity in February. However, factories had their busiest month in three years, buoying sentiment.
The dollar bought 105.39 yen, down 0.3% and a continued retreat from the five-month high of 106.225 reached Wednesday.
(Editing by Hugh Lawson and Pravin Char)
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