Morningstar DBRS Upgrades the Autonomous Community of Catalonia to BBB (high), Changes Trend to Stable

DBRS Ratings GmbH (Morningstar DBRS) upgraded the Long-Term Issuer Rating of the Autonomous Community of Catalonia (Catalonia) to BBB (high) from "BBB" and upgraded the Short-Term Issuer Rating to R-2 (high) from R-2 (middle). The trend on all ratings has changed to Stable from Positive.

KEY CREDIT RATING CONSIDERATIONS
The upgrade reflects the Catalan's fiscal consolidation that brought a better financial performance, which in combination with the financing support provided by the Kingdom of Spain to the regional government, has significantly improved its debt metrics, including a reduced debt burden and improved debt structure that lowered refinancing risks. In Morningstar DBRS' view, the relationship between the regional government and the national government has slowly but steadily strengthened over recent years. While the independence question is likely to remain a structural topic in the region over the medium to long term and sporadic tensions could re-emerge, Morningstar DBRS takes the view that the economic and financial institutional relationship between these tiers of government is likely to continue to normalize.

The Stable trend reflects Morningstar DBRS' assessment that the risks to Catalonia's credit ratings are currently balanced. Despite lower economic growth, the normalization of tax revenues in 2025 combined with the financial performance improvement of Catalonia supported by the return of the Budget Stability Law forms our view that Catalonia's fiscal and debt performance will continue to slowly improve in the medium term. Additionally, Morningstar DBRS continues to take the view that the debt relief that the central government has committed to implement for the autonomous communities, will take place although its impact on Catalonia's credit ratings could still be compatible with its credit rating and the timing is uncertain as of now.

CREDIT RATING DRIVERS
Catalonia's credit ratings could be upgraded if (1) the region continues its fiscal consolidation towards a balanced budget position and improves its debt sustainability metrics; and the debt relief mechanism were implemented and allows for a rapid and substantial reduction of Catalonia's debt burden, or (2) the region continues its fiscal consolidation towards a balanced budget position and improves its debt sustainability metrics and the Kingdom of Spain's credit rating were upgraded.

Catalonia's credit ratings could be downgraded if: (1) there were a structural deterioration in the region's fiscal performance, leading to a wider deficit and placing debt metrics on a deteriorating trajectory; or (2) the Kingdom of Spain's credit rating were downgraded; or (3), although unlikely, if there were indications that a material escalation of the political tensions between both government tiers could affect the financing support received by the region.

CREDIT RATING RATIONALE

Catalonia's Strong Fiscal Improvement Coupled With Return of Fiscal Rules Improves the Financial Performance Outlook

In 2024, Catalonia strongly improved its budgetary performance, with a financing deficit of 0.4% of GDP. This was the second year in a row of improvement after the slight improvement seen in 2023 that put an end to the deterioration seen in 2022. Most of this budgetary performance improvement stems from the very strong increase in operating revenues, up 18% from 2023, that has allowed the region to post an operating surplus of EUR 491 million after more than a decade of operating deficits. Morningstar DBRS views positively the fiscal improvement recorded by the region in 2024, though it may not represent a structural fiscal improvement. Morningstar DBRS continues to take the view that maintaining this strong performance in the near term will remain challenging since the settlement of the regional financing system will decrease for next year and economic growth prospects are weaker.

Regarding the stability references for 2024 of 0% deficit, Catalonia went above the reference, though improved fiscal results should still help the region's debt continue its decreasing trend. The 2025 stability targets have not been officially communicated, although the Spanish government assumed an average deficit for the regions of 0.1% of GDP. The regional government expects to reach a 0.1% deficit, but AIREF expects the region's financing deficit to deteriorate to 0.6% of GDP in 2025 and then to remain between 0.5% and 0.6% of GDP until 2029. Fiscal challenges will remain significant in 2025, with weaker economic prospects, in combination with ambitious lower expenditure growth benchmarks. Morningstar DBRS understands that the return of fiscal rules would leave a reduced fiscal margin for the regions to increase their expenditure significantly and expects the regions to keep the current track record of fiscal consolidation by reducing deficit levels after a slight deterioration in 2025.

Higher Growth of Revenues and GDP And Lower Debt Maturities Contributed to Improved Catalonia's Debt Affordability

Despite the fiscal improvement in 2023 and 2024, the persistence of financing deficits has caused Morningstar DBRS' adjusted debt stock to rise modestly, increasing to EUR 91.6 billion at end of 2024 from EUR 88.8 billion at YE2023. However, economic growth and fiscal revenues growth have strongly improved Catalonia's debt ratios. The adjusted debt-to operating revenues improved to 204% in 2024, down from 234% in 2023, or from 250% in 2022. Going forward, Morningstar DBRS expects Catalonia's debt ratios to keep decreasing in the medium term, though it expects the decreases to be less notable given a reduced rate of nominal economic growth and normalised fiscal revenue flows.

Moreover, the Catalan debt could potentially decrease even further than currently expected if there were a materialisation of the political commitment for debt relief to the regions. However, there is still uncertainty over the timing of this measure since the Ministry of Finance has deemed necessary to issue an organic law that could face difficulties for its approval in the short term given the need for a majority of the congress to pass the law, whilst currently the government was not able to gather enough support to pass other laws that were in the interest of all the political parties forming part of the government. For Catalonia, the measure is currently expected to amount to EUR 17 billion of the region's direct debt, assuming all other factors remain stable; its adjusted debt-to-operating revenue could improve to the range 160%-170% from 204% in 2024. Morningstar DBRS considers that such a mechanism would likely improve the financial metrics of the regions, although the magnitude of this improvement is likely to vary from one region to the other.

Additionally, the debt maturities are much lower now than the larger debt maturities that the region had to face in recent years, such as EUR 10.9 billion on average during 2019-2022, and Morningstar DBRS takes the view that debt management has improved with lesser concentration of debt maturities to reduce refinancing risk. The region will continue benefitting from the favourable conditions attached to available state financing, though it has managed to refinance some debt to shape its debt maturing calendar and will combine it with some multilateral loans for diversification purposes.

Internal Demand and Strength of Labour Market Supports the Economy Against Weaker External Demand

On the economic front, in 2023, Catalonia's GDP grew by 2.5%, slightly below the growth rate of Spain (2.7%), and is estimated to have grown by 3.2% in line with the national growth in 2024 according to AIREF, although the Catalan statistical institute estimates the growth at 3.6%, above the national average. The expected economic growth is supported mainly by the increase of consumption supported by job creation and real wages and higher investment. The regional economy is expected to continue growing broadly in line with the national average. Morningstar DBRS expects a continuation of strong tourism performance and also a robust job market performance to support Spain's GDP growth, but weaker external demand is likely to somewhat weigh on growth in 2025.

The positive trend in job performance that started at the end of the pandemic has continued so far, with the employment level reaching 56% in 2023, improving from 54% in 2021, and higher than the national average of 52% in 2023. Employment enjoyed particularly strong growth the public administration, in education, and in information and technology services in 2024 compared with the same period of 2023. Simultaneously, unemployment has been on a downtrend, decreasing to 8.9% at the end of 2024 from 9.4% at the end of 2023.

The domestic tourism sector, one of the most affected sectors during the pandemic, fully recovered in the first half of 2023 after a progressive rebound over the previous two years. This sector has kept growing, and tourist arrivals at hotels (domestic and foreign) grew by 2% over 2024, with overnight stays 3% over 2023 level. The financial resources expected from the Next Generation EU (NGEU) programme, including the Recovery and Resilience Facility (RRF) and REACT-EU funds, should continue to support reforms and investments. The region estimates revenue received related to these funds at around EUR 5.7 billion up to the end of 2025 and EUR 4.6 billion has already been spent; for 2025 and 2026 the expectation is to implement EUR 0.8 billion and EUR 0.3 billion respectively. Going forward, the speed of absorption of EU funds will remain a key area of focus for Morningstar DBRS to assess the full economic impact.

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

Social (S) Factors

The following Social factor had a relevant effect on the credit analysis: Passed-through Social considerations.

The Passed-through Social credit considerations had a relevant effect on the credit ratings, as the social factors affecting the Kingdom of Spain's credit ratings are passed-through to Autonomous Community of Catalonia.

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

Credit rating actions on Kingdom of Spain are likely to have an impact on this credit rating. ESG factors that have a significant or relevant effect on the credit analysis of Autonomous Community of Catalonia are discussed separately at https://dbrs.morningstar.com/issuers/15664.

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.

RATING COMMITTEE SUMMARY
Morningstar DBRS' European Sub-Sovereign Scorecard generates a result in the A (low) - "BBB" range. The main points discussed during the Rating Committee included the potential impact of the regional debt relief, the fiscal and debt evolution in 2024, the economic situation in the region and its outlook, and its financial forecasts.

For more information on the Key Indicators used for the Kingdom of Spain, please see the Sovereign Scorecard Indicators and Building Block Assessments: https://dbrs.morningstar.com/research/455417.

The national scorecard indicators were used for the sovereign rating. The Kingdom of Spain rating was an input to the credit analysis of the Autonomous Community of Catalonia.

Notes:
All figures are in euros unless otherwise noted.

The principal methodology is the Rating European Sub-Sovereign Governments (09 August 2024) https://dbrs.morningstar.com/research/437618. 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 Autonomous Community of Catalonia for financial position, budgetary execution and debt structure for the 2017-24 period, Bank of Spain for the debt stock during the period between 2016 and 2024, Independent Authority for Fiscal Responsibility (AIREF) for its May 2025 monitoring report on the Medium Term Fiscal and Structural Plan 2025-2028, Instituto Nacional de Estatística (INE), Ministry of Finance, General State Comptroller (IGAE) and the European Commission. national statistical agency, central bank, Ministry of Finance, IMF, World Bank. Morningstar DBRS considers the information available to it for the purposes of providing these credit ratings to be of satisfactory quality.

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://dbrs.morningstar.com/research/455815.

These credit ratings are endorsed by DBRS Ratings Limited for use in the United Kingdom.
Lead Analyst: Jorge Espinosa, Assistant Vice President, Global Sovereign Ratings
Rating Committee Chair: Thomas R. Torgerson, Managing Director, Global Sovereign Ratings
Initial Rating Date: 6 July 2018
Last Rating Date: 13 December 2024

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