Morningstar DBRS Confirms Kingdom of Spain at A (high), Stable Trend

DBRS Ratings GmbH (Morningstar DBRS) confirmed the Kingdom of Spain's Long-Term Foreign and Local Currency - Issuer Ratings at A (high). At the same time, Morningstar DBRS confirmed Spain's Short-Term Foreign and Local Currency - Issuer Ratings at R-1 (middle). The trends on all ratings are Stable.

KEY CREDIT RATING CONSIDERATIONS
The confirmation of Spain's credit ratings and the Stable trends reflect Morningstar DBRS' view that medium-term risks to the outlook are balanced. The country's large and diversified economy, competitive export sector, and euro area membership support the credit ratings. Healthy performance of service exports powered Spain's recent economic growth, and we expect favourable labour market conditions, falling interest rates, the recovery of purchasing power, and the deployment of European Union (EU) transfers to support domestic demand in the coming years. Spain was one of few countries whose growth projection for 2025, at 2.5%, increased with the IMF's update to its World Economic Outlook (WEO) in April 2025. Spain's credit quality is further enhanced by a steady improvement in public finances. Net of one-off costs related to unusual regional flooding, the fiscal deficit improved to 2.8% of GDP last year and the government anticipates it will record a primary balance this year. The government's medium term fiscal plan projects gradual fiscal consolidation and persistent debt reduction over the course of the decade.

Conversely, Spain's high public debt ratio and impediments to policy execution remain credit weaknesses. The government expects the pace of debt decline to slow over the next few years with debt to GDP stabilizing around the 100% mark. High debt narrows the government's fiscal space to respond to shocks, accommodate higher funding costs, or address increasing age-related expenditures. The government's recent commitment to reach the 2% defence spending threshold in 2025 and potential costs linked to shoring up the electricity grid following the blackout in April 2025 add previously unforeseen budgetary pressure. The fractured nature of Spanish politics generates uncertainty, weakens government stability, and has created conditions preventing the government's ability to pass the annual state budget. The institutional and territorial challenges posed by the pro-independence movement in the Autonomous Community of Catalonia appear to have reduced, though social and political tensions - now a persistent feature of Spain's political environment - weakens the government's ability to legislate key policies. Morningstar DBRS nevertheless expects the government to maintain its commitment to fiscal consolidation and to its recovery plan.

CREDIT RATING DRIVERS
The credit ratings could be upgraded if authorities significantly reduce the debt-to-GDP ratio, and if there is persistent evidence that reforms improve economic resilience and boost potential growth. The credit ratings could be downgraded if a worsening of the medium-term growth outlook or weaker fiscal discipline result in a sustained increase in Spain's already-high public debt ratio.

CREDIT RATING RATIONALE
Strong Performance of the Spanish Economy has been Broad-Based

Spain's favourable economic performance has been supported across various GDP components. Strong tourism and non-tourism services boosted external demand, while lower inflation and improved consumer purchasing power, the strength of the labour market, government support measures, healthy private sector finances, and absorption of EU investment funds have propped up domestic demand. Real GDP in Spain expanded by 3.2% last year, well above the euro area's average 0.9% growth rate. The European Commission (EC) forecasts growth to average above 2% over the next two years, continuing its multiyear overperformance of EU peers. Downside risks to the near-term growth outlook stem from a more pronounced downturn in Europe or an escalation in geopolitical tensions across various fronts that could cool external demand and once again drive-up energy prices and the rate of inflation.

Morningstar DBRS considers medium-term growth prospects to be contingent on persistent strength of the labour market and the government's ability to manage EU transfer grants and loans, including from the NextGenerationEU (NGEU) funds and the Multiannual Financial Framework (MFF). Employment growth in Spain has been steady, growing roughly 2% per year over the last five years, in part supported by large net inflows of migrants. The immigration windfall has been accompanied by a gradual decline in the unemployment rate (still high at 10.9% in March 2025) and a gradual increase in labour productivity per hour worked. On EU funds, Spain's NGEU Recovery Plan, if fully implemented, is set to mobilise up to EUR 163 billion by 2026 or roughly 11% of GDP in grants and loans. The amount increases to 13% of GDP by 2030 including the MFF. These investments are critical for Spain to improve on its capital stock and its ability to more rapidly converge towards the euro area's GDP-per-capita levels. The country has thus far made significant progress in the implementation of its recovery plan, but the macroeconomic effects on potential growth are difficult to estimate.

Near-Term Fiscal Deficit Reduction to Continue; Medium-Term Fiscal Pressures Remain

The government expects the primary fiscal position (net of interest payments) to reach balance this year - for the first time since 2007. The headline deficit peaked at 10.1% of GDP in 2020 and has steadily improved, reaching 3.2% in 2024 or 2.8% net of one-off costs linked to the extreme weather events in Valencia and other regions. The improvement in the fiscal imbalance in recent years stemmed primarily from revenue overperformance from strong nominal GDP growth and gradual unwinding of support measures. The government's medium term structural deficit plan expects the headline deficit of 2.5% of GDP in 2025 and to narrow further to 1.5% of GDP by 2029. Spain's independent fiscal authority (AIReF) considers the current medium-term targets unachievable in the absence of additional adjustments to public finances and expects a 2.9% of GDP deficit by 2029.

There are mounting risks to the steady narrowing of the headline deficit, as persistent spending demands and obstacles to policy implementation challenge the government's more favourable fiscal projections. The government's commitment to increase defence spending to 2% will likely require more medium-term budgetary adjustments, and additional spending pressures could stem from unforeseen costs linked to securing energy following the nation-wide black out in April 2025 and reform to regional government funding system. Over a longer time horizon, spending pressures mount on pensions, healthcare, and long-term care from the ageing population, from higher debt servicing costs, and from the materialisation of environmental risks (droughts, wildfires, floods, and other meteorological phenomena). The government's ability to confront these challenges is complicated by the current governing coalition, which consists of many parties with disparate preferences. The reoccurring delays in passing the state budget demonstrate the risk to effective and timely implementation of fiscal policies and reforms. Despite the uncertain path, Morningstar DBRS is of the view that Spain's fiscal consolidation track-record re-enforces its commitment to EU fiscal rules and to rebalancing public accounts.
Spain's Public Debt Ratio Is Falling but Remains High

Spain's high public debt ratio remains an important credit challenge. High debt reduces the government's fiscal space and increases its vulnerability to shocks. The path of debt reduction is nonetheless favourable, as the positive nominal interest-rate to GDP-growth differential and lower deficits are the drivers of the downward debt trend. After peaking at 120.3% of GDP in 2020, the government expects public debt to settle around 100% of GDP over the next few years, and its medium-term plan targets debt falling to 92.8% of GDP by 2030. While public debt remains high and above the euro area average, the Spanish Treasury has successfully managed the shocks associated with higher interest rates and funding costs. The predominance of fixed-rate bonds and a relatively long average maturity profile around 8 years delay the impact of higher issuance and interest costs. The government projects the interest burden to remain unchanged at 2.4% of GDP in 2025, up from 2.0% in 2021, but still below the 3.6% of GDP interest cost in 2013. It is worth mentioning that while bond yields increased in recent years, market spreads on Spain's benchmark 10-year bond against comparable German bunds narrowed to around 66 bps as of May 2025, a slightly tighter spread over bunds than equivalent French bonds. Morningstar DBRS makes a positive qualitative adjustment for the "Debt and Liquidity" building block assessment to reflect Spain's favourable debt structure, its downward sloping trajectory of the debt ratio, and membership of the euro system and the credibility of the ECB backstop.

Spain's External Accounts Are Strong, Despite Successive External Shocks

Spain's external accounts have significantly improved over the last decade. Spain posted average current account surpluses of 1.6% of GDP between 2012 and 2022, reversing a period of current-account deficits averaging 5.6% of GDP between 2000 and 2011. In recent years, Spain's current account surplus declined towards balance during 2020-22 because of the pandemic's effect on export volume and the sharp increase in energy import prices. Due to the strength of tourism and non-tourism service exports and lower energy prices the current account surplus reached 3.1% last year and the EC projects an average 2.7% of GDP surplus in 2025-26. The accumulation of current account surpluses, combined with healthy nominal GDP growth, explain Spain's large improvement in its net international investment position. It narrowed to -44.0% of GDP in 2024 from -93.8% of GDP in 2014. The country's membership in the euro system, it's diversified export base, and its current account surpluses mitigate against Spain's still-elevated net external debtor position and support the positive qualitative adjustment for the "Balance of Payments" building block assessment.

Spanish Banks Are Benefiting from Higher Rates and the Resilient Economy

The Spanish banking system remains healthy and financial stability risks appear contained. The banks have strong liquidity, are well capitalized, and are reporting record profits. Higher interest rates and the rapid repricing of variable-rate loans support strong bank earnings. Despite the rapid rise in interest rates, there has been no real deterioration in asset quality. Nonperforming loans as a share of total loans was 3.3% at end-2024, according to the Banco de España, down from 4.8% at end-2019. Furthermore, there appears to be limited risks from the housing market, despite the slow recovery in terms of new mortgage flows and transactions. Sluggish growth in the supply of new housing and higher construction costs mitigate the risks of a sharp correction in housing prices.

The Government Faces Persistent Impediments to Implementing Its Policy Agenda

Spain's general election in July 2023 did not give any party a clear majority, yet Prime Minister Pedro Sánchez garnered sufficient support to lead a coalition that includes the PM's centre-left Partido Socialista Obrero Español (PSOE) and the left-of-centre Sumar parties. The country's healthy governance metrics support Morningstar DBRS' view that the government will continue to pursue its fiscal objectives and to execute its recovery plan. The country's percentile rank scores of Worldwide Governance Indicators in 2023 for Government Effectiveness (76.9), Voice and Accountability (87.7), and Rule of Law (78.3) remain strong. The independence of public institutions will remain key for Spain to avoid any erosion of these governance scores.

The fractured nature of Spanish politics generates uncertainty, weakens government stability, and creates impediments to policy execution. Critically, the minority government's current mandate could be abruptly cut short if pro-independence parties decide to withdraw their implicit support. The agreements made between PSOE and the Catalan pro-independence parties, and particularly the amnesty law, have resulted in increased political and social tensions across Spain. The government's inability to satisfy political commitments or additional financial accommodations to the autonomous communities are also potential flashpoints, including the possible reforms to regional government financing and debt relief.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS
ESG Considerations had a significant effect on the credit analysis.

Social (S) Factors

The following Social factor had a significant effect on the credit analysis: Human Rights and Human Capital. Spain's GDP per capita, at USD 35,092 in 2024, remains relatively low compared with its European peers most likely reflecting still a higher structural unemployment rate and lower productivity. Nonetheless, respect for human rights is high. Morningstar DBRS has taken this factor into account in the Economic Structure and Performance building block.

There were no Environmental or Governance factors that had a significant or relevant effect on the credit analysis.

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings (16 May 2025) https://dbrs.morningstar.com/research/454196

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments at: https://www.dbrsmorningstar.com/research/455417.

EURO AREA RISK CATEGORY: LOW

Notes:
All figures are in euros unless otherwise noted. Public finance statistics reported on a general government basis unless specified.

The principal methodology is the Global Methodology for Rating Sovereign Governments (15 July 2024) https://dbrs.morningstar.com/research/436000. In addition Morningstar DBRS uses the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings https://dbrs.morningstar.com/research/454196 in its consideration of ESG factors.

The credit rating methodologies used in the analysis of this transaction can be found at: https://dbrs.morningstar.com/about/methodologies.

The sources of information used for these credit ratings include the Ministry of Finance (2025 Draft Budgetary Plan, Macroeconomic and Fiscal Forecast Update), Bank of Spain (Quarterly Report and Macroeconomic Projections for the Spanish Economy; 2024 Financial Stability Report), National Statistics Office, Independent Authority for Fiscal Responsibility, Spanish Treasury (Treasury's Presentation May 2025), State Official Gazette (Climate Change and Energy Transition Law, May 2021), EC (Spring 2025 Economic Forecast; 2025 Country Progress Report - Spain; Opinion on Draft Budgetary Plan 2025), EU's Economic and Financial Committee's Sub-Committee on EU Sovereign Debt Markets (ESDM), ECB, European Banking Authority, Eurostat, Bank for International Settlements, Organisation for Economic Co-operation and Development, IMF (WEO and IFS), World Bank, and Macrobond. Morningstar DBRS considers the information available to it for the purposes of providing these credit ratings to be of satisfactory quality.

With respect to FCA and ESMA regulations in the United Kingdom and European Union, respectively, these are unsolicited credit ratings. These credit ratings were not initiated at the request of the issuer.

With Rated Entity or Related Third Party Participation: YES
With Access to Internal Documents: YES
With Access to Management: NO

Morningstar DBRS does not audit the information it receives in connection with the credit rating process, and it does not and cannot independently verify that information in every instance.

The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. Morningstar DBRS' outlooks and credit ratings are under regular surveillance.

For further information on Morningstar DBRS historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see: https://registers.esma.europa.eu/cerep-publication. For further information on Morningstar DBRS historical default rates published by the Financial Conduct Authority (FCA) in a central repository, see https://data.fca.org.uk/#/ceres/craStats.

The sensitivity analysis of the relevant key credit rating assumptions can be found at: https://www.dbrsmorningstar.com/research/455416.

These credit ratings are endorsed by DBRS Ratings Limited for use in the United Kingdom.

Lead Analyst: Jason Graffam, Senior Vice President, Global Sovereign Ratings and Financial Institutions Group
Rating Committee Chair: Thomas R. Torgerson, Managing Director, Global Sovereign Ratings
Initial Rating Date: 21 October 2010
Last Rating Date: 29 November 2024

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