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

Despite a slight downward adjustment by Basque Country to its 2015 operating revenue causing a lower current balance than that indicated in preliminary data, Fitch has decided to maintain the Positive Outlook. It reflects the potential for an upgrade if the region extends its improvement in operating performance in 2016. The region's 2016 budget is forecasting that operating margin will rise to 7.7%, from 3.5% in 2015 and 3.2% in 2014.

An upgrade to 'A-' would place the Basque Country above the sovereign's rating of 'BBB+', which would be justified by the region's strong and diversified economy and significant tax autonomy.

The affirmation reflects the Basque Country's current good performance, with a GDP per capita equivalent to 130.6% of the national average in 2015. It also reflects continuing moderately weak operating margin and rather high direct debt.

KEY RATING DRIVERS

Expected Improving Operating Performance

For 2016-2017, Fitch expects the Basque Country's operating margin to gradually improve to 5%-7%, based on revenue growth driven by an improving national economy. The singular funding system of the Basque Country means tax revenues are correlated with its economic performance, while current expenditure is rigid due to the scope of responsibilities.

Nevertheless, Fitch's current expectations of improvement in fiscal performance take into account operating expenditure growth of 2%-3% in 2016, after the Basque Country lifted cost-containment policies. Regional elections are scheduled on 25 September 2016, and depending on the new policy of the next government, this could mean a change to our base case scenario.

With a GDP estimated at about EUR67bn and a GDP per capita above 30% of the national average, the Basque Country's economy is strong and diversified, with a solid and significant manufacturing sector (21.4% of nominal GDP) and with a higher-than-average employment rate of 48.4% in 2015 (46.4% nationally). Housing sales also illustrate a wealthier region with housing prices consistently 40% above the national average. The positive momentum in the economy is illustrated by the positive reversal in the labour market started in 2014, as total registered workers further rose 1.9% yoy in 2015, a trend that is being extended so far in 2016.

Moderately High Direct Debt

The expected improvement in fiscal performance will slow direct debt growth, which Fitch estimates will reach EUR8.6bn by end-2016. Direct debt will be close to 90%-95% of the Basque Country's current revenue at end-2018, versus 93% in 2015. Liquidity risk is limited as provincial administrations transfer tax revenues to the Basque Country every two months. Cash reserves increased to EUR563.3m in 2015 from EUR358m in 2014, covering more than 60% of the region's 2016 budgeted debt repayment.

RATING SENSITIVITIES

An upgrade may result from the operating margin remaining above 5% in the medium term, combined with no material change to the debt stock and structure. This is subject to the new government after the September elections and to Fitch's assessment of its main priorities.

The inability to report a structural positive current balance to cover a large part of its debt repayment could result in a downgrade, although this is currently not Fitch's base case scenario.