OREANDA-NEWS. September 16, 2015. Fitch Ratings has published Andorra's Long-term foreign currency Issuer Default Rating (IDR) of 'BBB'. The Outlook is Stable. Fitch has also published the Short-term foreign currency IDR of 'F2' and Country Ceiling of 'A-'.

KEY RATING DRIVERS
Andorra's 'BBB' IDR reflects the following key rating drivers:

Andorra is a small, wealthy and politically stable country. Its ratings are underpinned by a strong public sector balance sheet and a flexible labour market, but are constrained by the economy's small size, weak growth and high concentration in the tourism and banking sectors.

Andorra has a moderate level of gross general government debt, at 41% of GDP in 2014. Government debt grew from 15.7% of GDP in 2006 as a result of a multi-year recession. Debt/GDP is forecast by Fitch to peak in 2015 at 42.7%, before falling in 2016 as a result of the government's commitment to its consolidation strategy since 2010. General government surpluses (2015F: 0.9%, 2014: 2%) are driven by significant social security surpluses and a steady stream of dividend revenues from state-owned telecommunications and utilities companies, while the central government's deficit is expected to shrink gradually.

Government contingent liabilities are large due to an outsized banking sector in Andorra. Total banking sector assets were 6.9x GDP in 2014 (6x GDP for domestic banking sector assets), and are concentrated in four domestic banks and one foreign-owned bank that specialise mainly in private banking operations. Andorra lacks a lender of last resort, and there is no formal separation between domestic banking operations and other business activities of the Andorran banks. In the event of a systemic banking crisis, therefore, Fitch expects significant banking sector contingent liabilities could materialise on the sovereign's balance sheet. The economy could also be badly hit in such a tail risk scenario.

In April 2015, the Andorran government passed legislation accelerating the implementation of the European Bank Recovery and Resolution Directive (BRRD) from 2017, which may lessen the impact of the bank contingent liabilities on the sovereign's balance sheet.

The authorities intervened swiftly and applied the resolution law in the case of the recent bank crisis involving Banca Privada d'Andorra (BPA), to prevent a bank run on BPA following charges of money-laundering by the US Financial Crime Enforcement Agency (FinCEN). BPA is in the process of being broken up into a 'bad bank' and a 'good bank' that would be sold to private investors. An initial EUR30m fund financed by banks has also been established to provide additional capital for banks under the resolution law.

The BPA crisis has had a limited adverse impact on the viability of the other three large domestic banks. Net outflows of assets under management at these banks have remained fairly resilient, falling only slightly since the crisis. Capitalisation and asset quality metrics are adequate among these banks. However, the lack of reliable access to a lender of last resort, a weaker regulatory framework than its eurozone peers, and individual developments have led to downward pressure on Fitch's ratings for these banks (see "Fitch Downgrades 3 Andorran Banks" dated 3 July 2015).

The twin pillars of the Andorran economy - tourism and banking - faced severe shocks in 2008-2013 following a housing crisis, the global financial crisis, and the eurozone sovereign debt crisis, resulting in six consecutive years of contraction. The economy is heavily reliant on its neighbours Spain and France for tourism and goods exports. In particular, Spain accounted for 62% of goods exports and 48% of tourists in 2014.

Real GDP recovered to a 2.3% growth in 2014, primarily driven by growth in the financial sector (contribution to growth of 1.9pp). Growth in other sectors such as hospitality, industry and ICTs also exhibit a robust recovery path, highlighting improving business confidence and household consumption in Andorra. Fitch forecasts growth to slow to 1% in 2015 due to challenges in the banking sector, but to recover to 1.8% in 2016 as growth in the non-financial sector rebounds.

The government's consolidation measures included the implementation of a raft of extensive reforms to the tax framework in 2010-2014 - simplifying value-added taxes, introducing a new corporate tax and a new personal income tax. Public expenditure measures included a hiring freeze in 2014-2015 and changes to public sector pensions. Public finances are further supported by the government's liquid assets portfolio totalling 45.3% of GDP, giving the government a small net creditor position.

Andorra's monetary agreement with the EU permitting it to use the euro as its official currency, and to issue a small amount of euro coins, allows Andorra to import the ECB's credibility for low and stable inflation. Inflation is hence closely linked to price developments in the eurozone, in particular in Spain and France, and we forecast it to be -0.6% in 2015. A high degree of cross-border mobility between Andorra, Spain and France results in a lower unemployment rate than its neighbours. Unemployment was just 6.1% of the labour force at its peak in 2012, and has since reduced to 4.5% in 2014. This is reflected in a 9% fall in the population between 2008 and 2014 as jobseekers moved to the bigger cities in Spain and France.

RATING SENSITIVITIES
The Stable Outlook reflects Fitch's assessment that upside and downside risks to the rating are currently balanced.

The main factors that may individually or collectively lead to a negative rating action are:
-Worsening creditworthiness of the three large Andorran banks, increasing the risk of contingent liabilities crystalising on the sovereign's balance sheet or a large adverse impact on the real economy.
-Failure to resolve BPA smoothly, resulting in the state having to inject funds in a recapitalisation.
-A sharp deterioration in the real economy, which would weigh on the sovereign's debt dynamics.

The main factors that may individually or collectively lead to a positive rating action are:
-Successful economic diversification away from tourism and financial services, which would provide the economy with more buffers against shocks to these industries.
-Increased foreign ownership of the Andorran banks, which would reduce the risk of financial sector contingent liabilities crystalising on the sovereign balance sheet.
-Improvement to data reporting in terms of frequency and availability, showing a stronger position than currently assumed.

KEY ASSUMPTIONS
There is no balance of payments (BoP) or international investment position (IIP) data available. Where possible, Fitch has made conservative estimates and proxies for Andorra's external position using the consolidated balance sheets of the Fitch-rated Andorran banks.

Fitch assumes that the US authorities will not bring further money-laundering charges against the other Andorran banks.