Political developments in Spain (undecided), Portugal (stable) and Italy (divided) have rating-relevant implications for the three countries, visible in their diverging capacities to reduce high public debt burdens, says Scope Ratings.

The different political outlooks for three euro area member states with limited fiscal policy space highlight how governments can either: i) use still benign economic conditions to reduce elevated public debt burdens via active structural actions; alternatively, ii) rely on good economic times to reduce debt-to-GDP ratios via cyclical fiscal improvements absent structural initiative; or iii) use good times to reverse fiscal consolidation. Such decisions hold significant implications for addressing underlying fiscal imbalances and thus impact governments’ abilities to cope in a future economic downturn.

Spain (A-/Stable): “Spain faces its third general election in four years on 28 April: The crucial question is whether the vote will deliver a governing majority needed to implement reforms to lower the country’s public debt burden, reform the labour market and improve productivity,” says Alvise Lennkh, analyst at Scope. “Spain needs to escape the current political impasse to address remaining rating-relevant vulnerabilities.”

Spain’s debt-to-GDP ratio, which peaked in 2014 at around 100%, has remained relatively stable at around 97% in 2018 and is projected to decline only modestly to 92% by 2024, according to the latest IMF forecasts published last week.

Such a relatively modest decline despite high growth rates (2.5% in 2018) is due to the country’s high structural primary deficits of around 3% of GDP, amongst the highest in the euro area. Successive minority governments since 2016 have not addressed this issue.

Two key political developments lie ahead: First, the electoral outcome in April (with around 40% of the Spanish electorate still undecided, and 15% unsure whether they will vote for the right or the left), and secondly, whether events in Catalonia (dependent on the outcome of the trial of separatists) also result in new regional elections later this year.

Political cooperation between the central government and the Catalan regional authorities that creates the conditions for economic and fiscal reforms would be credit positive, while an extension of the political paralysis observed over the past few years – for instance, via a hung parliament or a continued insistence on independence by the Catalan leadership – would constrain the rating at the current A-/Stable level.

Portugal (BBB/Positive): “Portugal is benefiting from a relatively stable political environment, even with a minority government, which is why we expect continued leadership from the Socialist Party after October’s parliamentary elections and, with that, a broadly unchanged fiscal policy stance over the coming years,” says Lennkh.

The governing Socialist Party (PS) currently has a 10pp polling advantage over the conservative Social Democratic Party ahead of elections scheduled for 6 October. It is unclear whether the Socialist Party would lead a second minority government or seek to form a majority coalition after the elections, though the expected policy continuity in a second PS-led government should limit major fiscal reversals.

Portugal’s policy continuity is also observed in budget developments. Public debt peaked in 2014 at 131% of GDP, but it has since declined to around 121% in 2018. The latest IMF forecasts project the decline to resume to around 103% of GDP by 2024, on the back of primary surpluses and modest growth.

Italy (BBB+/Stable): “The governing coalition of Five Star Movement and Lega still faces significant challenges regarding improving the sustainability of Italy’s public debt despite some fiscal moderation following extensive interactions with the European Commission,” says Dennis Shen, analyst at Scope.

The government raised its 2019 deficit expectations to 2.4% of GDP recently (from 2.04%) – compared with Scope’s expectation for a 2019 deficit of 2.5% of GDP. Scope projects Italy’s debt trajectory to be flat to slightly rising, reaching 133% of GDP by 2020-21, from 132% in 2018.

Lega has a clear advantage in the recent opinion polls with around 32.5% of voting intentions, compared with a steep decline to 21.5% for the Five Star Movement. So, the right-wing party could hypothetically lead a new majority centre-right government were there to be early parliamentary elections after European elections next month.

Fiscal profligacy risks look unlikely to disappear in Italy whether the current coalition survives for longer or Lega ends the current government and ends up leading a new government.