Government Moves Underpin Spain Regions, but Risks Remain

The establishment of the Fondo de Liquidez Autonomico (Regional Liquidity Fund (FLA)) is an example of the strong support by Spain’s central government for its regions as they face unprecedented liquidity challenges, according to Fitch Ratings. This support is already factored into the ratings of some of the weaker regions.

The credit ratings agency (CRA) believes that fiscal and liquidity situation of the regions is extremely challenging, with a real risk that deficit targets for the autonomous communities in 2012 may be exceeded. Nevertheless, Fitch views the FLA and other recent government measures as positive.

The FLA was established this month with an initial €18bn. It enables the regions to tap central government liquidity for refinancing maturing obligations and deficit funding. This represents a temporary solution to the Spanish regions’ liquidity constraints, driven by sharp rises in debt and the closure of the capital markets, and eases the CRA’s near-term concern about their liquidity.

The regions’ refinancing need for the next six months, including additional debt to cover the deficits projected in their Economic and Financial Plans, is around €16bn, so Fitch regards the present limit of the FLA as sufficient for this year. However it is likely that the amount would need to be increased in 2013 if a large number of regions drew from it. So far Valencia, Catalonia and Murcia, with combined financing needs of around €9bn to the end of the year, have said that they will tap the FLA.

All Fitch-rated regions except the Basque Country (A) are in the BBB category, with negative outlook. However, the credit fundamentals of both Catalonia (for its high debt burden and negative operating balance) and Castile-La Mancha (for its significant deficit) are weaker than their present rating level of BBB- would suggest. Their ratings are underpinned by the strong implicit and explicit support of the state as articulated through policy statements and through recently introduced mechanisms. These include the FLA and tighter monitoring of the regions’ fiscal position, with central government having the right to directly intervene if any region deviates from agreed deficit targets. Fitch rates Spain BBB with a negative outlook.

The Spanish autonomous communities have been authorised a combined deficit of 1.5% of gross domestic product (GDP) in 2012 (compared to 3.3% reported in 2011). In 2013, the regional deficit must be reduced to 0.7%. Fitch considers these targets hugely challenging particularly in the present economic climate, which makes fiscal recovery difficult. Although a number of drastic measures both on the revenue and expenditure side have been implemented, there is a high risk that the deficit limit may be exceeded this year. It is essential therefore that the central government maintains strong vigilance over regional finances and acts promptly in case of deviation from planned deficit targets.

Fitch said that it will monitor the ability and continued willingness of central government to support and control regional finances. Any weakening of this support would result in negative rating actions for some regions.

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