OREANDA-NEWS. January 19, 2016. 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, its high level of direct debt, and its strong economy. The Stable Outlook incorporates Fitch's expectations that its fiscal performance will gradually improve and that direct debt will rise until 2017 to 175%-187% of projected current revenue (167.6% in 2014).

KEY RATING DRIVERS

Weak but Improving Operating Performance
Madrid's new government has approved its first budget in 2016, and overall Fitch considers that Madrid's operating performance should gradually improve, with an operating margin of 4%-6% on average during 2016-2017 (-3.5% at end-2014). This is based on revenue growth driven by an improving national economy. Operating expenditure, which has been declining since 2009, is likely to grow 2% yoy on average over 2015-2017, after the autonomous community lifted cost-containment policies.

New Regional Assembly
The regional elections in May 2015 resulted in a coalition government of the centre-right wing party Partido Popular (PP) and the centre-wing party Ciudadanos, after the PP was governing with an absolute majority in the last five mandates. The new President, Ms. Cristina Cifuentes, was the Delegate to the central government of the regional government, and we expect some continuity with a strong intention to comply with fiscal targets and improved transparency.

The approved 2016 budget relies on a 9% yoy growth in operating revenue, driven by higher allocation of resources from the central government and stronger own taxes. The budget also forecasts operating expenditure restraint, with a 4% yoy growth, particularly with respect to social programmes and health spending. The current balance is budgeted to be positive at EUR773m for 2016, after having been negative in the 2013-2015 budgets.

General elections were held in December 2015, and debate on a new funding system for Spanish regional governments will commence. The features of the new funding system will be a key rating consideration in Madrid's IDRs. Nevertheless, Fitch considers it is too early to assess the related impact.

Strong and Recovering Regional Economy
With a nominal GDP estimated at EUR197.7bn in 2014, Madrid contributes to 19% of the Spanish economy. It is the main political, administrative and economic center in Spain (BBB+/F2/Stable). Its strong economy is also illustrated by a higher-than-average employment rate of 51.9% in 2014 versus 45% nationally. Madrid's economy is recovering as nominal annual GDP grew 0.86% in 2014 and in November 2015 job creations rose 3.8% since December 2014 (3.3% in Spain). Job creations increased by a cumulative 7%, in 2014 and 2015, compared with 9.4% job losses between 2008 and 2013, reflecting the current recovery underway in the region.

High Direct Debt
Fitch estimates Madrid's direct debt to have grown significantly in 2015 to EUR27bn-EUR28bn or 179% of current revenue, from EUR23.7bn at end-2014 (167.6%). Despite some implemented cuts in capital spending, direct debt rose by EUR14.5bn between 2010 and 2014.

Strong Access to External Liquidity
Madrid has had 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 had not applied to the Regional Liquidity Fund state support mechanism until 2014. In 2015, the central government's introduction of the new Fondo de Facilidad Financiera zero interest rate loans for regional governments compliant with stability goals helped ease Madrid's commercial debt financing. Nevertheless, Madrid in 2015 managed to fund a larger proportion of its annual deficit through capital market debt and bank loans bearing moderate interest rates and with a long amortisation period. For 2016, Madrid intends to continue to access the markets to fund its deficits.

RATING SENSITIVITIES
The 2016 budget indicates a current margin of 4.6% and Fitch will monitor its execution, especially fiscal changes and the evolution of the main spending items. A sharp deviation from our projections with a negative current balance could drive a revision of the Outlook to Negative from Stable.

An operating margin consistently exceeding 5% and direct debt-to-current revenue dropping from its current level (167.6% in 2014) could drive a positive rating action.