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Spanish Autonomous Communities' Access to State Funding Mechanisms Reduces Interest and Refinancing Risks

After a long period of extremely low interest rates, the European Central Bank (ECB) has been rapidly raising its benchmark policy rate to combat higher and more persistent-than-expected inflation in the euro area. This will likely lead to higher interest expenditures for the public sector in Spain and weigh on fiscal performance. Given their high debt levels, Spanish autonomous communities (ACs) could be particularly affected. DBRS Morningstar takes the view that regions' high share of fixed interest rate debt and their overall favorable average debt maturity should reduce the immediate impact of rising interest costs.

The regional governments' access to the state's funding mechanisms over the last decade explains, to a large extent, the regions' favourable debt profile and has significantly reduced both interest and refinancing risks for the regions. This in our view supports the credit standing of ACs, though it effectively transfers additional costs to the central government. State funding mechanisms consist mainly of direct loans from a State Finance Agency, effectively borrowing even below sovereign yields.

Key Highlights include:
• Intergovernmental debt accounts for half of the autonomous communities’ debt stock
• State funding mechanisms are a safeguard for autonomous communities in the current rising interest rate environment
• Long-term budgeting will need to accommodate higher interest costs

“Despite the high debt burden, we believe Spanish Autonomous Communities are well-placed to withstand rapidly raising interest rates,” said Jorge Espinosa, Assistant Vice President in the Global Sovereign Ratings Group. “Autonomous Communities’ access to the state funding mechanism has been the key driver to reduce interest and refinancing risk for the sector”.