S&P Global Ratings assigns credit ratings to local and regional governments (LRGs) based on its qualitative and quantitative analysis of a range of financial, economic, managerial, and institutional factors. Our analytical framework for rating LRGs is articulated around six major components, resulting from our methodology:

• The institutional framework;
• Economy;
• Financial management;
• Budgetary performance;
• Liquidity; and
• Debt burden.

Our assessment of the institutional framework is an important component of the rating. The institutional and legislative environment in which an LRG operates provides an important context in which to evaluate the LRG's individual credit profile. Therefore, we combine our assessment of the institutional framework and the five other factors listed above to determine an indicative credit level for an individual LRG. We then adjust this level for certain overriding factors to provide the final rating for the respective LRG (see "Methodology For Rating Local And Regional Governments Outside Of The U.S." published July 15, 2019).

LRG Characteristics By Rating Category

We expect the credit quality of rated European LRGs to remain resilient despite the projected global economic cooldown this year. In our view, the eurozone economy, in which most rated LRGs are located, will emerge from stagflation in the second half of 2023 thanks to falling inflation and tourism returning to normalized levels.

Still, elevated inflation and persistently tight labor markets will result in higher spending pressures for LRGs over the next 12-18 months, in our view. This will lead to a decrease in average budgetary performance and a short uptick in debt for rated LRGs.

Real investment spending will drop as budgetary pressures tighten for most LRGs based on higher prices. Spanish LRGs (especially autonomous communities), Italian LRGs, and those in Central and Eastern Europe remain the exception because they receive large transfers from the Next Generation EU mechanism while having solid economic performance. We recently raised ratings on two Spanish LRGs and revised one outlook to positive from stable.

However, higher-for-longer inflation will pressure LRGs' interest costs. It will also increase refinancing risks, particularly for lower-rated LRGs that have limited access to deep capital markets. Interest expense has already increased substantially for LRGs with a relatively high share of floating-rate loans or that had to refinance a significant portion of debt.

We think most of our ratings on European LRGs remain resilient to periods of stress. Both our five-year forecasts on balance after capital accounts as a percentage of total revenue and tax-supported debt as a share of consolidated revenue have been largely unchanged since 2018 within their respective rating categories.

Chart 1

Chart 2

'AAA'

LRGs in the 'AAA' category are spread across Germany, Norway, Sweden, and Switzerland. They operate within institutional frameworks that are extremely predictable and supportive, and generally have strong economies. All LRGs show prudent financial management practices that promote detailed long-term planning and good internal and external risk management. Most LRGs within this category enjoy very good access to external liquidity to fund any unexpected short-term financial need. We upgraded the Region of Skane (Sweden) in April this year from 'AA+' based on improved budgetary control, and upgraded the two Swiss Cantons Basel Country and Aargau at the end of 2022 from the 'AA' category. There have been no downgrades in this 'AAA' category since our previous publication in September 2022, reflecting the stability of ratings in this category.

Other common characteristics among LRGs at this rating level include:

• High median levels of national GDP per capita in 2022, at about $56,058, with very high local GDP per capita, particularly in Switzerland;
• Strong budgetary performance. In the next few months, high inflation will cushion the economic slowdown and its impact on budgetary performance. Median operating surpluses are strong, at about 8.5% of operating revenue in 2022, based on very strong tax revenue. The five-year (2021-2025) median average operating surpluses will decrease to 7.1% of operating revenue as spending will increase, in our view. We expect small deficits after capital accounts over 2021-2025 with a median of 0.3%. Elevated inflation will keep revenue up, while we expect expenditure to continue catching up from 2023, and we expect some delayed investment spending over the outlook horizon;
• A low-but-slightly increasing debt burden. We expect median tax-supported debt will increase to 33.8% of consolidated operating revenue on average in 2021-2025, based on weak expected economic growth this year and higher spending; and
• Very low and stable median levels of interest in an international comparison, which are set to increase to about 0.7% of operating revenue from 0.3% in 2022, but remain low in an international context.

Table 1

Table 2

'AA'

The largest number of rated European LRGs are in the 'AA' rating category, with 49 entities across 10 countries: Austria, Belgium, Czech Republic, France, Germany, Norway, Spain, Sweden, Switzerland, and the U.K. Most 'AA' rated LRGs operate within institutional frameworks that are very predictable and well-balanced, except for the Czech municipalities, the Spanish special status regions, and the French departments, which operate within evolving institutional frameworks. They counterbalance strong economies and prudent financial management with moderate performance (French departments and Spanish special status regions) or very strong financial indicators (Czech municipalities).

Financial management practices promote detailed long-term planning and good internal and external risk management. In general, LRGs in this category reflect weaker credit profiles than their 'AAA' peers because of weaker institutional frameworks and higher debt burdens.

Since our most recent publication in 2022, we added two newly rated French LRGs, namely Department of Mayenne and Intercity of Cergy-Pontoise. We also upgraded the City of Lausanne in June to 'AA-' from 'A+' on improved liquidity and robust budgetary performance.

Key economic and financial risk indicators for 'AA' rated LRGs are:

• High median national GDP per capita of about $52,414 in 2022, which is lower than the median GDP level for 'AAA' rated LRGs. Some 'AA' rated entities benefit from very high local GDP per capita, such as Swiss cantons and cities, as well as Swedish municipalities and regions.
• Strong budgetary performance. The 'AA' rated LRGs have sound operating surpluses and somewhat higher deficits after capital accounts than higher-rated entities. We anticipate that the median five-year average (2021-2025) operating surplus will decrease to about 7.5% of operating revenue, which is similar to 'AAA' rated entities, and the median average balance after capital accounts will be slightly weaker posting negative 1.5% of total revenue.
• Moderate debt burden. We project median levels of tax-supported debt at 87.2% of consolidated operating revenue for 2021-2025, which is somewhat higher than peers in the 'AAA' category. Median interest payments are low but rising. We forecast these will average about 2.0% of operating revenue in 2021-2025, which is higher than for most rating categories.

Table 3

Table 4

'A'

LRGs in the 'A' rating category are in France, Latvia, Poland, and Spain. LRGs in this category typically operate within evolving institutional frameworks, and their financial management practices are usually strong or average. In general, institutional frameworks are less predictable and supportive than of those entities in the 'AA' category, and their individual credit profiles are weaker due to less robust economies, and higher debt burdens.

Since our previous publication, we upgraded the Autonomous Community of Andalusia in April 2023 to 'A-' from 'BBB+' on an improving budgetary performance. We withdrew the rating on the City of Olomouc in September upon the issuer's request.

'A' rated LRGs exhibit the following common characteristics:

• Sound median levels of national GDP at about $29,462 in 2022.
• Budgetary performance is generally similar to that of 'AAA' and 'AA' rated peers. We expect the median operating balance will be about 8.3% of operating revenue, with a balanced budget after capital accounts in 2021-2025.
• The indebtedness of 'A' rated LRGs is moderate and for some, higher than that of higher-rated peers. For 2021-2025, we expect median tax-supported debt to be 77.1% of consolidated operating revenue. We also expect median interest at about 2.3% of operating revenue, which is the highest ratio among all LRGs in EMEA. LRGs in Eastern Europe have higher ratios because of predominantly variable interest rates on their borrowings.

Table 5

Table 6

'BBB'

The LRGs in the 'BBB' category--the lowest category within the investment-grade segment--are spread across Italy, Spain, Bulgaria, and Poland. Italian LRGs generally benefit from a relatively sound economic wealth and supportive institutional framework, but in many cases our ratings on them are constrained by the sovereign rating.

Spanish LRGs in the 'BBB' category benefit from central government transfers, which will continue normalizing after elevated levels in recent years. Spanish regions will profit from EU grants to sustain more ambitious investment programs, without generating an adverse impact on their deficits after capital accounts. The debt burden of Spanish regions remains relatively high, but manageable, and they also benefit from access to central government funded liquidity facilities, which cover their entire funding needs. LRGs in Eastern Europe operate in less-supportive institutional frameworks and less wealthy economies, but their debt burdens are generally modest.

The entities that we rate at this level share the following characteristics:

• Same median levels of national GDP per capita as the 'A' category, at about $29,462 in 2022, but with entities featuring very low local GDP per capita in Bulgaria and Poland;
• Modest budgetary performance. We expect median operating balances to account for 4.1% of operating revenue on average in 2021-2025. This is lower than entities rated 'A'. Similar to the 'A' category, however, median after-capital accounts are balanced on average; and
• An average-to-high debt burden, below that of 'A' rated peers. We project the median tax-supported debt at about 46.9% of consolidated operating revenue in 2021-2025, which somewhat balances large differences between LRGs in this category. Some LRGs have significantly higher tax-supported debt burdens, especially among the Spanish rated LRGs, resulting from large deficits before 2014 and a gradual budgetary consolidation since. We estimate that median interest level will remain stable at 1.1% of operating revenue over 2021-2025.

Table 7

Table 8

'BB'

We rate three LRGs in the 'BB' rating category. Two are Central European capital cities, namely the City of Zargeb (Croatia) and City of Skopje (North Macedonia). Our ratings on these are significantly constrained by relatively weak institutional frameworks, coupled with weak financial management systems and practices, and counterbalanced by sound budgetary performance and relatively low-to-moderate indebtedness. Croatia benefits from the positive momentum created by EU and eurozone accession. This is reflected in our recent revision of the trend for the institutional framework under which Croatian LRGs operate to improving from stable, as well as the positive outlook on our rating on Zagreb.

We also rate the Autonomous Community of Valencia in the 'BB' category, which is significantly different from other rated Spanish LRGs. Although it operates within a stronger institutional framework, we view the region's financial management as weak, and it has demonstrated weak budgetary performance and a very high debt burden, significantly above Spanish peers'.

LRGs in the 'BB' category generally have weak economies, limited access to external liquidity, and relatively weak institutional frameworks, which underpin a degree of vulnerability. These systems are unpredictable and subject to change, so we consider that they could have higher credit risk than investment-grade LRGs. They also share the following features:

• Low median national GDP per capita, at about $18,289 in 2022;
• Good budgetary performance, with high median operating surplus of about 11.6% of operating revenue in 2021-2025. We anticipate that the deficit after capital accounts will be about 1.3% of total revenue. Valencia in particular is estimated to record substantially weaker budgetary performance than rated peers; and
• Generally low indebtedness in North Macedonia, contrasted with a very high debt level in Valencia. We expect the median tax-supported debt to account for 93.6% of total revenue over 2021-2025. In contrast, we estimate that Valencia's tax-supported debt average will reach 317.2% of total revenue. We forecast interest will be lower than in the 'BBB' category, at 0.7% of operating revenue over 2021-2025. This is due to LRGs in Eastern European countries, which mainly borrow from multilateral lending institutions.

'B'

We rate only the Republika Srpska (in Bosnia & Herzegovina) and Fergana Region (in Uzbekistan) in the 'B' category. They have the following characteristics:

• Fergana operates under a weaker institutional framework and financial management than Srpska.
• Fergana demonstrates a moderate budgetary performance due to a better economic setup than Srpska.
• Therefore, Fergana has almost no debt and interest costs, whereas Srpska shows a weaker budgetary performance and is fairly indebted.

'CCC'

We only rate the City of Kyiv in this category. This is primarily based on the impact the Russian invasion of Ukraine has had on the sovereign and city. In September 2022, we lowered the ratings on Kyiv to 'CCC+' from 'B', with a stable outlook. Since then, we have affirmed the rating.

Table 9

Table 10

National scale ratings

We only rate LRGs in Israel using a national scale in Europe, the Middle East, and Africa (EMEA). Almost all LRGs operate within evolving institutional frameworks, and their financial management practices are usually average. Israeli entities benefited from solid economic growth, with manageable liquidity levels, and have the following characteristics:

• A high national GDP per capita of about $54,658 in 2022.
• Moderate-to-weak budgetary performance, with operating margins averaging 4.0% over 2021-2025 and a moderate-to-very weak deficit after capital accounts of 0.7%.
• The average tax-supported debt, which we project at about 25.8% of consolidated operating revenue in 2021-2025, is in line with the low indebtedness levels of Eastern Europe LRGs. Interest is also very low, at 0.8% of operating revenue, one of the lowest among rated peers in EMEA.

Table 11

Table 12