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Fitch Downgrades Catalonia to 'BB'; Outlook Negative

Source: Reuters - Fri 13th Nov 2015
Fitch Downgrades Catalonia to 'BB'; Outlook Negative

Fitch Ratings downgraded the Autonomous Community of Catalonia's Long-term foreign and local currency Issuer Default Ratings (IDR) to 'BB' from 'BBB-' and removed them from Rating Watch Negative (RWN).

The Outlook is Negative.

The Short-term foreign currency IDR is downgraded to 'B' from 'F3'. The EMTN programme and senior debt ratings have also been downgraded to 'BB' from 'BBB-'. Under EU credit rating agency (CRA) regulation, the publication of sovereign reviews (including under the regulation Local and Regional Governments) is subject to restrictions and must take place according to a published schedule, except where it is necessary for CRAs to deviate from this in order to comply with their legal obligations.

Fitch interprets this provision as allowing us to publish a rating review in situation where there is material change in creditworthiness of the issuer that we believe makes it inappropriate for us to wait until the next scheduled review date to update the rating or Outlook/Watch. In this case the deviation was caused by Catalonia passing a resolution on 9 November for formally commencing the process for independence.

Therefore, Fitch has decided to temporarily suspend the rating floor for the Autonomous Community of Catalonia of 'BBB-'. The rating floor applies to all Spanish regions benefitting from the various liquidity measures introduced by the central government to support the regions' finances, including the regional liquidity fund (FLA) to ensure refinancing of maturing obligations.

However, the rating floor is also subject to a cooperative relationship between the regions and the central government, which is not the case for Catalonia given recent events. The rating of Catalonia now reflects its intrinsic credit profile.

KEY RATING DRIVERS

The downgrade of Catalonia's IDR reflects the following key rating drivers and their relative weights: High On 9 November, the regional parliament passed a resolution to formally start the process for independence from the rest of Spain.

This resolution was passed by the "pro-independence" parties with 72 votes in favour and 63 against. The constitutional court has suspended the resolution under request from the central government. Fitch acknowledges the central government has wide powers to intervene in the affairs of the Catalan government. It includes the withholding of both ordinary funds and extraordinary liquidity support, and the suspension of the regional autonomy under article 155 of the Spanish Constitution and direct central government control.

Whatever measures the central government decides to adopt, it is likely to result in increased tensions between the two governments and possible civil disruption in the region. Medium Inter-governmental relationship between the central and the regional governments is now at a low ebb. The Catalan government has stated its insubordination to any decision taken by the Constitutional court and is likely to ignore any suspension.

This will lead to further confrontation between the Catalan and the central governments as well as with the Constitutional court. Catalonia's 'BB' IDR and Negative Outlooks also reflect the following main factors: The region posted wide negative current balances over 2008-2014 (averaging -16%), and will need funding to finance its expected budget deficit in 2015, which Fitch expects to be around 2% of regional GDP, and over medium term. These deficits are expected to be around 20% of regional revenue over the 2015-2017 period.

Catalonia's liquidity is fragile and there is uncertainty as to whether the region will continue to receive liquidity support from the central government under the same terms, but Fitch expects present debt servicing to continue to be met under the FLA, eventually complemented with market funding. Against this background, a debt burden, measured as direct debt to current revenue, of nearly 3x the budget is inconsistent with its previous investment-grade rating.

However, the regional economy is recovering faster than Spain, and nominal GDP grew 1.3% against 0.9% nationally in 2014. Preliminary data for 1Q15 indicate Catalonia was among the top Spanish regions in GDP growth. The trend is gaining momentum and is likely to prevail. At this stage Fitch assumes the process of independence will not disrupt economic activity. The Negative Outlook reflects our expectation for a weak budgetary performance and growing debt.

RATING SENSITIVITIES

Fitch will continue to monitor developments in Catalonia and may take further negative rating action as appropriate. However, if the situation normalises, the region will again be supported by the rating floor. All other Spanish regions continue to benefit from the rating floor of 'BBB-'.

KEY ASSUMPTION

Fitch assumes that the region will continue to have access to the FLA for debt servicing purposes over the medium term.

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