Fitch Ratings: Spain Vote Points to Continuity, and May Ease Catalonia Risks

The outcome of Spain's general election, which saw the ruling Socialist Party (PSOE) strengthen its position, suggests broad economic policy continuity and less risk of a near-term escalation in Catalonia-related tensions, Fitch Ratings says. Significant structural fiscal tightening appears unlikely, but we do not expect a marked loosening relative to the fiscal forecast at our most recent sovereign review in January.

Sunday's vote saw PSOE win 123 seats in Spain's lower house, the Congress of Deputies, up from 85 seats in the previous parliament (where it had relied on the support of the left-wing Podemos and regional parties). A tie-up with Podemos would fall 11 seats short of the 176 required for a majority. Bringing in regional (but not pro-independence) parties would still leave this combination one seat short of a majority.

The latest PSOE statements indicate a preference for forming another minority government rather than a formal coalition, while the Spanish press has reported that Podemos favours a more formal coalition arrangement. A coalition between PSOE and the centrist Ciudadanos would secure a majority, but Ciudadanos's leadership has reiterated its intention to lead the opposition rather than join the next administration.

Talks between the parties may not conclude until after European Parliamentary and Spanish regional elections on 23 May. The election - Spain's third in four years - highlights the fragmentation of political opinion in recent years. The centre-right Popular Party, which was in office until June last year, lost around half its seats, and the far-right Vox will be represented in Spain's national parliament for the first time. The likely absence of a stable majority coalition could mean that the new government again fails to see out a full term.

As we noted prior to the election, the main potential implications for Spain's sovereign credit profile relate to fiscal policy and the path of public debt/GDP, and to tensions between Madrid and the Catalan regional government.

A sharp increase in Catalonia-related tensions is, in our view, less likely as the centre-right and right-wing parties that backed the suspension of regional autonomy under Article 155 of the constitution are unlikely to feature in the next government. Moreover, PSOE, which takes a more conciliatory stance, won a majority in the upper house, which would have to approve the triggering of Article 155.

Nevertheless, underlying tensions, for example over calls for a referendum on self-determination, remain. Progress towards resolving these will also depend on political developments within Catalonia, where the election saw a strong performance by separatist parties. Spain's 'A-'/Stable rating incorporates a qualitative, one-notch downward adjustment to that implied by our Sovereign Rating Model to reflect the possibility of sustained, heightened tensions causing a significant negative impact on credit fundamentals.

We do not expect the election result to lead to sizeable additional fiscal loosening, partly because of some moderating effect from Stability and Growth Pact rules on the pro-EU PSOE. A broad continuation of current fiscal settings is reflected in our fiscal deficit forecasts of 2.1% in 2019 and 1.8% in 2020, down from 2.5% in 2018.

However, deficit reduction is still cyclical rather than structural. Strong economic and labour market indicators suggest that GDP growth will continue to support Spain's fiscal position, with data last week showing 1Q19 growth of 0.7% qoq, above our March Global Economic Outlook projection of 0.5%, underscoring the country's macroeconomic resilience. Our fiscal forecast implies a broadly unchanged structural balance. High public debt and the absence of structural fiscal adjustment are key sovereign rating constraints.