S&P Global Ratings' current economic forecasts for Spain, which reflect its estimate of the impact of the coronavirus pandemic, point to a sharp contraction in economic activity in 2020, followed by a rebound over 2021-2022. We estimate nominal GDP will contract by 7.5% in 2020. This will have an effect on Spanish regional budgetary performance, which we expect to weaken because of the pandemic, but only moderately thanks to government extraordinary support and increased revenue from the regional financing system.
After our most recent publication on the topic in April (see "COVID-19: Spanish Regions' Budgets Will Deteriorate In 2020, But Institutional Strengths Mitigate The Risks," published April 7, 2020, on RatingsDirect), the central government announced on May 3 a recovery fund of up to €16 billion for the regional governments, which was established by Royal Decree on June 16, 2020, and is now pending final parliamentary approval. Regions will receive nonreimbursable transfers in July, with further disbursements in September, November, and December. The details about allocation by region aren't yet public. This fund will support regional budgetary performance and liquidity needs through 2020. According to our estimates, net borrowings for 2020 are set to increase by 1.3x 2019 levels--however, they would have likely been 4.7x higher without the support.
In this report, S&P Global Ratings answers questions market participants have asked about Spanish regions: How the pandemic will affect budgets, what kind of central government support they can expect, and what the long-term implications might be.
S&P Global Ratings acknowledges a high degree of uncertainty about the evolution of the coronavirus pandemic. The consensus among health experts is that the pandemic may now be at, or near, its peak in some regions but will remain a threat until a vaccine or effective treatment is widely available, which may not occur until the second half of 2021. We are using this assumption in assessing the economic and credit implications associated with the pandemic (see our research here: www.spglobal.com/ratings). As the situation evolves, we will update our assumptions and estimates accordingly.
Frequently Asked Questions
Will the pandemic lead to a contraction in regional operating revenue?
Spanish normal status regions (NSRs) derive on average more than 80% of their operating revenue from the regional financing system. NSRs receive advances each year based on their expected collection of shared taxes (mainly personal income, value-added, and excise taxes). These advances are later compared with actual tax collection, and the system is settled two years after. If advances are too conservative, a positive settlement results, while if advances were too generous, the reverse happens. Once communicated to the regions, these advances are guaranteed for the year.
In 2020, transfers from the financing system will increase by 7.3%. In fact, the central government decided in March to increase them, when the pandemic's potential impact on the economy was starting to become apparent. In our view, this is a deliberate policy decision from the central government, designed to shore up regional finances by effectively disconnecting the majority of their revenues for the year from the impact of the economic downturn on tax collection.
Given that tax collection will be lower than expected, the system will likely generate a large negative settlement to be deducted from regional financing in 2022. We expect, however, that the central government will allow regions to return this settlement over several years, as it did for negative settlements arising from the financing system advances of 2008 and 2009. On the other hand, because of Spain's lockdown since March 14, 2020, NSRs will collect lower own taxes, particularly those related to real estate transactions, as well as fees and charges, in our view. These own sources of revenue, while significantly affected, only account for about 15% of NSR operating revenue on average. We therefore expect operating revenues for NSRs would likely still have risen for the year, even without central government support. The additional €16 billion will give a major boost to regional revenue to deal with the costs of the pandemic.
Are Spanish regions facing a surge in operating expenditure?
With the most recent available data, as of April 2020, regional operating expenditure is about 8% higher than at the end of April 2019, with health care costs rising by about 14%. On average, we estimate that operating expenditures for the whole sector might increase by 11% in 2020. This estimate is subject to a great deal of uncertainty, as it depends on the course that the pandemic takes in the second half of the year. The expenditure growth figures for each individual region will depend not just on the relative incidence of the pandemic, but also to other factors like the flexibility and efficiency of each regional health care system, and the willingness of the region's financial management to reprioritize spending.
Spanish regions are responsible for managing health care in their territories, which on average represent about 40% of their expenditure budget. Regions also manage education and social services, areas that will face additional pressures on spending as well. All regions have had to increase their operating expenditure to deal with the pandemic, for example hiring additional medical personnel and acquiring equipment and medicine. While the most affected regions will see much higher overall increases in expenditure, even those with comparatively smaller outbreaks are having to boost their spending to achieve greater preparedness.
We expect operating expenditure will decline in 2021, assuming the pandemic subsides, although we think part of the extra operating expenditure is likely to remain in the budget. This is because we understand regions will need to step up their vigilance and readiness to address any new outbreaks, at least until a vaccine or treatment for the virus are developed.
Will the central government's extraordinary COVID-19 fund be sufficient to absorb the impact?
The central government has not announced the overall amount for each region, and we expect this information will be made clear only gradually. The first tranche of €6 billion to cover additional health care expenditures will be disbursed in July, and based on published criteria, this will favor those regions the highest incidence of the virus. The second tranche, worth €3 billion and also related to health care, will be disbursed in November, taking into account population figures, and variables like ICU admissions, tests carried out, and number of cases at the end of October. The third tranche, worth €2 billion, will support regional expenditures in education, and will be distributed according to the size of population going through primary, secondary and college education. The final tranche, of €5 billion, will include €800 million to cover losses of revenue of the country's major transportation systems, and €4.2 billion to cover the loss of own revenues. This will be distributed according to the relative weight of real estate transaction taxes, vehicle registration taxes, and gambling taxes for each region over the past the years, as well as the overall population figures.
Taking into account the central government support and updated resources coming from the financing system, we now expect Spanish regions to post a deficit after capital accounts of 4.3% of total revenue in 2020. One year ago, in June 2019, we estimated the overall deficit for 2020 at 2.7% of total revenue. We estimate that, without central government support and all else equal, the deficit after capital accounts for the regional tier in 2020 could have reached up to 12% of total revenue (see chart).
Therefore, while we expect deteriorating budgetary performance, we believe central government support will be key in mitigating the impact on regional budgets and avoiding a more pronounced impact. However, we believe each regional management's willingness to comply with fiscal targets and consolidation path will also influence individual performance. In particular, individual budgetary outcomes will depend on the measures regional governments take, for example, to moderate investments or reprioritize operating expenditure to absorb part of the impact. Our budgetary estimates are subject to significant uncertainties, particularly the evolution of the pandemic, as well as the strength of the economic recovery.
Will the pandemic affect the revenues and expenditures of NSRs and special status regions (SSRs) equally?
NSRs and SSRs operate under different institutional frameworks. NSR derive the majority of their resources from the regional financing system, which partially pools tax collection to distribute equalization transfers among regions, thus breaking the direct link between individual tax collection and funding. On the other hand, SSRs have their own tax collection power and do not participate in equalization transfers. Part of the tax proceeds are transferred to the Spanish state to compensate for services provided in their regions.
The functioning of the financing system, which allows normal status regions to receive revenues from the central government in advance for the year, shields regions during an economic shock, as has been the case during the pandemic. Once the central government communicates advances to the regional tier, that revenue becomes certain for regions, and they receive them as monthly installments. Moreover, in case of need, NSRs may request an intrayear advance of these transfers, to bridge any liquidity needs. On the other hand, SSRs are more exposed to the economic cycle due to the nature of their institutional framework. Therefore, under an economic shock such as the pandemic and the impact on revenue is immediate. On the expenditure side, SSRs have very similar responsibilities compared with NSRs, with a high proportion of their responsibilities related to healthcare (38%) and education (30%). Therefore, under COVID-19, SSR expenditure pressure is very similar to that for NSRs.
Will SSRs also participate in the central government extraordinary COVID-19 support fund?
We understand that the central government has so far differentiated the treatment of NSRs and SSRs with respect to the fund. All regions will participate from the funds destined to cover additional expenditures in health care and education, but according to the published royal decree, SSRs will not participate in the €5 billion fund designed to cover shortfalls in tax collection. We believe this is because SSRs are responsible for managing their own revenue and have the flexibility and autonomy to modify their resources as needed.
Both the Basque Country and Navarre will partially benefit from the recovery fund, despite a longstanding record of independence from central government support. We believe that the use of this support will allow SSRs to partially absorb the impact of the virus on their budgets without making otherwise necessary extreme expenditure adjustments, so this will mitigate the impact of COVID-19 on SSR budgetary performance in 2020. However, we see this support as one-off. Transfers under this fund are not conditional, and do not entail any additional supervision of SSR finances by the central government. This fund does not diminish their budgetary autonomy. We therefore think that both regions will make use of this fund in an opportunistic way. Moreover, we expect the central government support to account only for about 6% of 2020 operating revenues, which we view as fairly limited.
Given the one-off nature of this support, its voluntary nature, its moderate impact on revenues, and the lack of any sort of conditionality, we do not believe this questions the ability of the SSRs to maintain a rating above the sovereign, if this continues to be warranted by their own credit profiles. Similarly, we do not believe that the central government's temporary measure warrant a change in our SSR institutional framework assessment. Should this type of support become a recurrent feature of the SSRs' financial standing, or should the regions avail themselves or such support repeatedly, we might reconsider our institutional framework assessment as well as our approach of rating these entities above the sovereign.
How will regions cover their financing needs in 2020?
We expect central government liquidity facilities to remain key for the regional tier liquidity over our forecast period (2020-2022). As of June 24, the central government liquidity mechanisms disbursements stood at €31 billion, which is already about 66% of our estimated regional borrowing needs for the year 2020. We estimate that by the year's end about 93% of the regional financing needs will be covered through loans (including central government liquidity facilities), while bonds will cover about 7%.
We also expect that well-established issuers such as the region of Madrid and the Basque Country will remain active in the financial markets. Both issuers have placed bonds in periods of markets stress, including during the peak of the pandemic in the country. Madrid has issued €2.3 billion in bonds so far in 2020, and the Basque Country €745 million.
When does S&P Global Ratings expect regional budgetary metrics to recover?
We expect Spain's GDP growth to recover strongly, and in proportion to its large drop in 2020. We currently estimate national nominal GDP growth will reach 6.9% and 6.2% in 2021 and 2022, respectively. However, these estimates are subject to a high degree of uncertainty given that the economic recovery will also depend on the length of the pandemic and potential outbreaks toward the end of the year, and the development of any potential vaccine.
For NSRs, we expect operating revenue in 2021 to decline, due to the one-off nature of the €16 billion COVID-19 fund. Notwithstanding this, we think financing system transfers in 2021 might only increase moderately. This is because 2020 funding through the regional financing system will in all likelihood prove far higher than warranted by tax collection in the year. At the same time, we expect operating expenditures to scale back because the one-off purchase of health care equipment will no longer be necessary. Nevertheless, we think that part of the expenditure increase of 2020 could become structural, as regions could enhance vigilance and preparedness for any secondary outbreaks.
In 2022, NSR budgetary performance could deteriorate slightly. We expect the settlement of the 2020 financing system will be large and negative, which would normally have a significant impact on regional revenue two years later, when the system is settled (in 2022, in this case). However, we expect that the central government will likely allow regions to return the negative settlement over several years, as was the case with the negative settlements in 2008 and 2009. Regions are currently returning negative settlements over 20 years, and we could expect a similar approach in this case. This reflects our view about the Spanish institutional framework for NSRs as supportive.
For SSRs, we expect the economic recovery to be in line with that of Spain's economic recovery given their revenue exposure to the economic cycle. Once the economy resumes growth, the Basque Country and Navarre should see tax collection increasing immediately. On the expenditure side, in a similar way as for the NSRs, we believe that some of the additional expenditures could become structural in that both regions might also prepare for any potential second waves of the virus. We therefore expect a gradual recovery of the SSR budgetary performance up to 2022.
Has S&P Global Ratings taken any rating actions on Spanish regions because of the pandemic?
So far, we have taken two rating actions on Extremadura and the Canary Islands. We revised our outlook on Extremadura from positive to stable, given that its 2019 performance was below our expectations and we believe it could be further strained by the pandemic. We revised our outlook from stable to negative on the Canary Islands, because we expect COVID-19-related travel restrictions and lockdowns worldwide could limit the region's economic prospects and hamper its budgetary performance beyond our expectations. We expect the Canary Islands to be one of the regions most affected from the pandemic, given its high exposure to tourism and because it could face higher pressure on its social expenditure budget due to its weaker-than average socioeconomic indicators.
- Spain's Autonomous Community of Canary Islands Outlook Revised To Negative; 'A' Rating Affirmed, May 29, 2020
- Spain's Region of Extremadura Outlook Revised To Stable On Expected Weaker Budgetary Performance; Affirmed At 'BBB/A-2', April 24, 2020
- Sovereign Risk Indicators, April 24, 2020. Interactive version available at http://www.spratings.com/sri
- COVID-19: Spanish Regions' Budgets Will Deteriorate In 2020, But Institutional Strengths Mitigate The Risks, April 7, 2020
This report does not constitute a rating action.
|Primary Credit Analysts:||Alejandro Rodriguez Anglada, Madrid (34) 91-788-7233;|
|Marta Saenz, Madrid + 34 91 788 7231;|
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