Fitch Ratings has affirmed Andorra’s Long-Term Foreign-Currency Issuer Default Rating (IDR) at ‘BBB+’. The Outlook is Stable.
A full list of rating actions is at the end of this rating action commentary.
Under EU credit rating agency (CRA) regulation, the publication of sovereign reviews is subject to restrictions and must take place according to a published schedule, except where it is necessary for CRAs to deviate from this in order to comply with their legal obligations. Fitch believes that the correction of the error described in the paragraph below warrants such deviation from the published schedule and makes it inappropriate for Fitch to wait until the next scheduled date to review the ratings.
At the review on Friday 10 August 2018 Fitch reported that its proprietary Sovereign Rating Model (SRM) assigned Andorra a score of ‘A’ on the Long-Term Foreign-Currency (LT FC) IDR scale. This score was calculated on the basis of a retired version of the SRM. The current version of the SRM assigns Andorra a score of ‘A-‘. The change in the score reflected marginal changes in weights and coefficients of model variables owing to the re-estimation of the model. Fitch believes that this constitutes a significant error according to its internal procedures, and that it is necessary to review the sovereign ratings of Andorra outside of the published schedule.
However, after the adjustment in the internal model of Fitch, there has been no change in Andorra’s ratings since the review of 10 August (when Andorra’s ratings were upgraded).
KEY RATING DRIVERS
Andorra’s ‘BBB+’ IDR and the Stable Outlook reflect the following key rating drivers:
The country’s wealth, political stability and low net public indebtedness are balanced by the economy’s small size (estimated USD2.7 billion in 2017), the risks associated with a large banking sector and weak economic data availability and frequency.
In 2017, general government debt fell below 40% for the first time since 2011, reaching 37.6% of GDP (in line with the ‘BBB’ peer median). We expect the government debt ratio to fall further, reaching 35.0% of GDP by 2020. The sovereign balance sheet is enhanced by a large stock of liquid assets, mainly in the social security sector. The general government net asset position was around 17% of GDP at end-2017.
Fiscal financing flexibility has improved in recent years. At the same time, the average maturity of debt is still relatively short (3.5 years at end-March 2018). The Andorran authorities have reduced the overall cost of debt through the replacement of bank loans with bond issues.
Andorra recorded a small surplus of EUR9 million (0.3% of GDP) at the central government level in 2017. The surplus was lower than that recorded in 2016 (0.9% of GDP), owing to lower direct tax receipts with broadly unchanged expenditure. Surpluses among local governments and the social security fund supported a higher surplus in 2017 at the broader general government level of 3.3% of GDP, albeit lower than in 2016 (4.4%).
For 2018, Fitch expects a slightly higher deficit at the central government level compared with the government’s budget target (around 1.3% of GDP compared to 0.9%). At the general government level, we expect a surplus of 1.0% of GDP in 2018 will declining to 0.7% by 2020 due to lower surpluses in the social security sector. Overall, we expect government finances to develop in line with the authorities’ fiscal rule introduced in 2014, which envisages a limit of 1% of GDP on the central government deficit and a 40% government debt to GDP ratio ceiling.
The recovery in the Andorran economy has gathered pace, in our view. Real GDP growth was 1.9% in 2017, with private sector services (excluding finance) and construction the main drivers of growth. At the same time, over a five-year period, GDP growth has lagged behind the peer median (forecast of 1.9% compared to 3.7%). With the pick-up in economic activity, the labour market has seen improvements. Unemployment fell to an average of 2.4% in 2017, from 3.5% in 2016. This compares with a forecast ‘BBB’ median of 7.9%.
We expect the stabilisation of activity in the financial sector and positive growth dynamics in other sectors to translate to overall real GDP growth of 2.2% this year, and 2% in 2019 and 2020. Inflation averaged 1.1% in 1H18, and we expect the full-year inflation rate to be 1.5%. We then expect inflation to edge up only slightly to 1.7% by 2020.
The Andorran authorities are continuing to align the regulatory environment, especially in the financial sector, with international and European standards, including the adoption of international standards of transparency and exchanges of information for tax purposes. Parliamentary procedures are underway to transpose several pieces of EU legislation and regulation into Andorran law, including the Capital Requirements Directive IV package, which implements the Basel III set of measures.
The average Viability Rating of Andorran banks is ‘bbb’. The large size of the banking sector represents a contingent liability for the sovereign, as banking sector assets were 5.3x nominal GDP at end-2017. The lack of a lender-of-last-resort in the financial sector restricts policy options in the event of an adverse shock and increases banking sector risks. In the event of systemic disruption in the banking sector we would expect some liabilities to materialise on the sovereign balance sheet. At the same time, banks’ capitalisation is adequate – the Andorran banking sector as a whole had a capital ratio of 21.7% at end-2017. Non-performing exposures are significant but on a downward trajectory, and their coverage with loan provisions has significantly improved.
SOVEREIGN RATING MODEL (SRM) and QUALITATIVE OVERLAY (QO)
Fitch’s proprietary SRM assigns Andorra a score equivalent to a rating of ‘A-‘ on the Long-Term Foreign-Currency (LT FC) IDR scale.
Fitch’s sovereign rating committee adjusted the output from the SRM to arrive at the final LT FC IDR by applying its QO, relative to rated peers, as follows:-
– Structural factors: -1 notch, to reflect the relatively large banking sector that makes the economy and the sovereign balance sheet vulnerable to the impact of banking crises particularly in the absence of a credible lender-of-last-resort in the financial sector; and to reflect limited, albeit improving, availability of economic data.
A combination of improvements in the economic outlook, including the labour market, and improvements in macroeconomic data availability and frequency has warranted a removal of -1 notch under the Macroeconomic factors.
The change in the SRM score from the previous review is small on the cusp between ‘A-‘ and ‘A’, but led to the model migrating to a lower score to ‘A-‘ from ‘A’.
Fitch’s SRM is the agency’s proprietary multiple regression rating model that employs 18 variables based on three-year centred averages, including one year of forecasts, to produce a score equivalent to a LT FC IDR. Fitch’s QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM.
The main factors that could, individually or collectively, lead to positive rating action are:
-Reduced risk of contingent liabilities from the banking sector materialising on the sovereign balance sheet
-Improvements in data quality and frequency, in particular for the external accounts
-Continued declines in the government debt to GDP ratio
-Improvements in medium-term growth prospects
The main factors that could, individually or collectively, lead to negative rating action are:
-Rising government indebtedness, for example due to fiscal slippage or worsening economic prospects
-A deterioration in the creditworthiness of the large Andorran banks, increasing the risk of contingent liabilities crystallising on the sovereign’s balance sheet
Fitch has not included the potential costs of financial damages from the lawsuit brought by Banca Privada d’Andorra’s former owners against the government in its public finance projections.