OREANDA-NEWS. Fitch Ratings has affirmed the Autonomous Community of Madrid's (Madrid) Long-Term Foreign and Local Currency Issuer Default Ratings (IDRs) at 'BBB' with Stable Outlooks. Fitch has also affirmed the Short-Term Foreign Currency IDR at 'F2'. The ratings on the senior unsecured outstanding bonds have been affirmed at 'BBB'.

The affirmation reflects Madrid's still weak fiscal performance in 2015, high direct debt, but also a strong economy. The Stable Outlook incorporates Fitch's expectations that the region's fiscal performance will gradually improve and that direct debt will rise to 180%-185% of current revenue by 2017 from 179.4% in 2015.

KEY RATING DRIVERS

Weak but Improving Operating Performance

General elections for Spain were held in June 2016, and debate on a new funding system for Spanish regional governments should start, with a possible review of fiscal policies and possible changes to the responsibilities of regional governments. This will be a key rating consideration for Madrid's IDRs, as projections would be subject to change.

Madrid's new government approved its first budget in 2016, and overall Fitch expects the region's operating performance to visibly improve this year, with an operating margin of 3%-4% (-0.8% at end-2015). This is based on projected revenue growth of 6.5% yoy, driven by an improving national economy and also due to a large 2014 revenue settlement from the funding system that Madrid will receive in 2016.

Operating expenditure, which has been declining since 2009, is likely to grow 2% in 2016-2018, after the autonomous community lifted its cost-containment policies.

At end-2015, Madrid posted a weaker-than-expected result with a negative current balance of EUR867.5m (negative EUR1.2bn in 2014), partly due to a one-off item in health spending. This weak result was also attributed to the current funding system to which Madrid is a net contributor. This is illustrated by the funding Madrid receives from the central government being 7% per capita below the average of the other 14 regions under the common regime in 2013.

New Regional Assembly

Following the May 2015 elections, a new government was formed in Madrid between the former centre-right wing party Partido Popular (PP) and the centre wing party Ciudadanos. This resulted in a new political agreement to prioritise social programmes, health spending and improved disclosure of information. The new President, Ms. Cristina Cifuentes, was the representative of the central government in Madrid's regional government, and we expect some continuity in fiscal policy with a strong intention to comply with fiscal targets.

Strong Regional Economy Recovering

Madrid shows a better-than-average economic profile, with a GDP per capita 36.6% above Spain's average in 2015. It is the main political, administrative and economic centre in Spain (BBB+/F2/Stable). Its strong economy is also illustrated by a higher-than-average employment rate of 53.6% in 2015 versus 46.4% nationally. Madrid's economy is recovering as nominal annual GDP grew 3.8% in 2015 to an estimated nominal EUR203.6bn. Madrid created cumulative 8% more jobs between December 2013 and May 2016, after having shed 9.4% jobs between 2008 and 2013, reflecting the economic recovery underway in the region.

Rising Direct Debt

Madrid's direct debt grew significantly in 2015 to EUR26.8bn or 179.4% of current revenue, (EUR23.7bn or 167.6% in 2014). Fitch estimates direct debt to grow in 2016 to EUR28bn-EUR29bn, or 175%-185% of current revenues. Overall debt repayments for the next three years are of EUR5.6bn, or 21% of outstanding direct debt at end-2015. However, this is mitigated by its strong access to external liquidity.

Strong Access to External Liquidity

Madrid has strong access to capital and commercial markets to fund its annual deficit, even during adverse times. Consequently, it is one of the few Spanish regional governments rated by Fitch that did not apply to the Regional Liquidity Fund state support mechanism until 2014.

In 2015, the central government's introduction of the Fondo de Facilidad Financiera zero interest rate loans for regional governments that have been compliant with stability goals helped ease Madrid's commercial debt financing. Nevertheless, Madrid last year funded a larger proportion of its annual deficit through capital market debt and bank loans bearing moderate interest rates and with a long amortisation period. In 2016, Madrid is continuing to borrow from markets to finance its budgetary needs and debt redemption. It has to date this year borrowed bank loans and issued debt of EUR2.6bn, at moderate interest rates.

RATING SENSITIVITIES

A negative operating balance reported in 2016, possibly driven by higher-than-expected operating expenditure growth, would trigger a downgrade of the IDR. Additionally, the region's inability to stabilise direct debt in the medium term could also lead to a negative rating action.

The ratings could be upgraded if the regional government reports a positive current balance and reduces direct debt to around 110% of current revenue.