Spain’s political impasse continues: policy vacuum constrains the sovereign credit rating outlook

Any prediction on the outcome of the elections, let alone the formation and policies of Spain’s next government, thus looks premature.

“Voter fatigue, raising questions about the parties’ relative abilities to mobilise their electorate, and last-minute voting shifts – with a significant share of the Spanish electorate still undecided – prevent us from drawing conclusions from the latest opinion polls,” says Alvise Lennkh, analyst at Scope.

Any number of outcomes seem possible: a repeat of the current stalemate, a strengthened PSOE not needing the implicit support of Catalan independence parties but still dependent on Unidas Podemos (UP), a shift of the electorate to the political right (mostly benefitting the Partido Popular (PP)), and a move back towards a quasi-bipartisan political landscape with the PSOE cannibalising support for the left-wing UP and the PP absorbing most of the votes of the right-wing Vox and both traditional parties poaching votes from the centre-right Ciudadanos.

“After a four-year contemplative pause since the height of the euro area crisis, Spain’s politics is as uncertain as ever,” Lennkh says.

The political stalemate contrasts with Spain’s still robust economic performance. The economy is growing slightly above 2% this year, 1% above the euro area average. Financing rates for the government have dropped to a historic low, with the average cost of issuance at just 0.37%. In addition, the resilience of the Spanish economy has improved, with growth now being mostly driven by domestic as opposed to external factors.

However, Spain’s economic and fiscal outlook is clouded by elevated fiscal and external imbalances, impediments to growth from labour-market rigidities and poor productivity, as well as the politically delicate question of regional autonomy. Scope highlights five main challenges that constrain Spain’s sovereign rating at the A- level:

Fiscal imbalances: While recognising significant fiscal adjustments during and following the crisis, Spain’s still-large fiscal deficit and negative structural primary balance point to relatively weak fiscal consolidation in recent years. Addressing this imbalance and ensuring the long-term viability of the pension system are key to reducing elevated public debt of around 97% of GDP.

Labour market rigidities: Unemployment has halved to around 14% in the past six years, converging towards underlying structural unemployment levels. Still, the prevalence of temporary contracts, high long-term unemployment and a large proportion of low-skilled jobs limit Spain’s human-capital development.

Low productivity: Total factor productivity is well below the euro area average, in part due to skills mismatches, labour-market duality, barriers to competition and regulation hindering small, productive businesses from growing.

External imbalances: While low interest rates and a change in the composition of external debt – from financial institutions to the central bank and the government – mitigate external debt sustainability risks, external debt has remained at a similar level for the past 10 years, cementing Spain’s large negative net external position (-77% of GDP), which is only gradually improving due to recent current account surpluses.

Regional financing: To address recurring regional political pressures and related uncertainty, further reforms to the regional financing arrangement, including the revenue equalisation system, with all regions, including those seeking greater independence such as Catalonia, are needed.

“So far, robust growth has covered some of the underlying structural challenges of Spain,” says Giulia Branz, analyst at Scope. “However, as the global and European economic outlook has weakened, Spain needs a stable government to address remaining economic, fiscal and political credit challenges,” she says.