On July 20, 2018, S&P Global Ratings affirmed its ‘BBB/A-2’ long- and short-term foreign and local currency sovereign credit ratings on Andorra (Pyrenees). The outlook is stable.
The stable outlook balances our expectation of robust economic activity and sound fiscal performance against risks related to the large size of Andorra’s financial sector.
S&P could raise the ratings if
- Andorra improves its institutional strength and economic resilience by successfully completing negotiations on its association agreement with the EU or accession to the International Monetary Fund (IMF). These agreements would provide access to emergency funding in case of any future financial crises;
- Greater availability of statistical data were to prompt us to improve our assessment of Andorra’s external position.
S&P could lower the ratings if:
- Andorra’s economy performs so far below our expectations that it has structural repercussions for its income levels or fiscal outcomes;
- S&P perceived heightened risks in the country’s financial sector, and considered that this could have a material effect on the country’s economy and the government’s fiscal prospects.
RATIONALE
The affirmation reflects our view that next year’s general elections are unlikely to hinder the steady reform progress Andorra has achieved in converging on global standards of financial reporting and supervision.
It also reflects our expectation that the economy will continue to benefit from the robust economic growth of its main trading partners, Spain and France. We also expect that the Government of Andorra will retain its net creditor position over the next two years, given our forecast of very low central government fiscal deficits and high level of the government’s liquid assets. Our view of these credit strengths is counterbalanced by Andorra’s large financial sector compared with the size of its economy and its lack of monetary flexibility.
Institutional and Economic Profile: Steady progress on negotiations with the IMF and alignment with global standards, coupled with robust economic growth Andorra continues to make progress on its negotiations with the IMF.
S&P expect further progress on the government’s reform agenda, which is leading to convergence with international practices in financial supervision.
S&P expect Andorra’s economy to expand by 1.5% on average over 2018-2019, in real terms, supported by robust economic growth in neighboring Spain and France.
Andorra’s stable and mature political institutions support generally effective policy-making in the country.
The center-right party, Democrats for Andorra, led by Prime Minister Antoni Martí Petit, governs the Principality and has an absolute majority. The next elections will take place before the end of March 2019. However, S&P doesn’t foresee that a potential change in government would delay or disrupt the country’s reform agenda. The legislation was supported by a broad consensus in parliament and we consider that the main economic stakeholders support the country’s alignment toward global standards of financial supervision and reporting.
The ratings could benefit from the successful completion of the ongoing negotiations for Andorra’s association agreement with the EU and accession to the IMF. If concluded on favorable terms, this accession could improve the country’s ability to deal with the repercussions of future financial crises.
S&P also believes both processes could have the additional benefit of improving the quality, transparency, and comparability of the country’s statistical information.
Policymaking in Andorra has generally been effective in recent years, promoting the sustainable public finances demonstrated by the country’s past two years of fiscal surpluses at all government levels. The fiscal sustainability law approved in 2014 limits the fiscal central government deficit to 1% of GDP and the indebtedness level to 40% of GDP.
The government is making progress toward convergence with international financial regulation and supervision practices. In June 2017, the Global Forum (OECD) provisionally graded Andorra “largely compliant” with regard to its exchange of information under request standards; the Global Forum will complete its evaluation on this matter in 2019. The first automatic exchange of information will happen next September 2018.
Economic growth is heavily dependent on Andorra’s main trading partners (Spain and France) and follows the same trend–after being subdued over 2014-2016, it started to recover in 2017. For 2018-2019, S&P forecasts average real GDP growth of about 1.5% in Andorra.
Three sectors dominate Andorra’s economy: financial services, tourism, and commerce. All are deeply interlinked and correlated. Andorra’s dependence on Spain is particularly acute–Spain is the main source of the country’s visitors and the key client of its financial services. Additionally, over half of Andorra’s exports are to Spain, while 64% of its imports come from this partner.
The government has been active in promoting other sectors of the economy, but significant economic diversification is unlikely to occur in the next two years.
Flexibility and Performance Profile: Andorran government will remain a net creditor, but exposed to high contingent risks.
Overall, we forecast general government fiscal surpluses of about 1.2% on average for 2018-2021. We expect moderate central government deficits, which we estimate at about 0.5% of GDP for 2017-2021, and which will modestly raise central government debt”, reports S&P.
We expect local governments to continue posting surpluses, aided by increased transfers from the central government. This should enable local governments to reduce leverage further.
Furthermore, if the social security system reports further surpluses, they would continue to accumulate in Andorra’s retirement pension fund. This supports our expectation that Andorra will maintain its net creditor position
at above 14% of GDP through 2021.
Andorra issued €520 million in debt in 2017. The government’s financial policy focuses on increasing the average maturity of its debt and lowering its cost.
Average debt maturity as of March 2018 had extended to 3.6 years, from 2.9 years in 2016, and the average cost of debt is now around 1.1%. S&P estimates that the Andorran government’s refinancing needs for 2018 amount to about €205 million (7% of GDP), for which the central government will issue additional debt this year to roll over these debt instruments, in line with its debt-management strategy.
The high contingent liabilities from Andorra’s large financial sector constrain our debt assessment. As of end-2017, assets under management represented 17.3x our estimated 2017 GDP, while deposits were about 3.6x GDP.
Following the collapse of Banca Privada D’Andorra (BPA) in 2015, the financial sector has stabilized.
Any potential banking crisis could have repercussions for the country’s budget and lead to debt accumulation. Moreover, the BPA resolution process remains subject to litigation, which could impose costs on the government in the case of an adverse court ruling.
“We still consider that Andorran banks‘ very large size and international expansion expose the Andorran government to high potential contingent liabilities. Financial institutions’ claims on the resident nongovernment sector, at about 1.5 x 2017 GDP, are among the highest of the sovereigns we rate. Andorra’s financial sector contributes about 20% of total GDP and approximately 5% of salaried employment (at year-end 2016), which highlights the country’s vulnerability to any potential turbulence in this sector”, reports S&P.
The Andorran authorities and banks continue to improve risk-management policies and oversight, while supervisor Autoritat Financera Andorrana (AFA) and the financial intelligence unit (Unitat d’Intel·ligència Financera d’Andorra; UIFAND) have expanded their resources. Banks are adopting International Financial Reporting Standards 9 (IFRS 9) from 2018 to make theirm financial reports comparable with international peers.
Convergence with international norms and transparency standards will tend to lower the risk arising from the banking sector. At the same time, they consider that it will test Andorra’s banks’ current business model–they will have to compete on an even playing field with much larger global players.
Despite improving standards, they still view the international footprint of Andorran banks as a potential source of risk. S&P estimates the banks’ activity outside Andorra continues to grow as a proportion of the total banking sector.
Other contingent liabilities are limited, as the sovereign’s public companies have consistently reported positive performance, providing additional revenues to the central government instead of requiring transfers.
“Our view of Andorra’s creditworthiness remains constrained by the country’s lack of an independent monetary policy, given its use of the euro as the official currency since 2011. Although Andorra lacks a lender of last resort, we recognize that Andorran banks have indirect access to liquidity from the European Central Bank through their subsidiaries in the eurozone”, reports S&P.
Because of a lack of sufficient external data, S&P evaluates Andorra’s external position starting from our view on Spain, the country to which its economy is most closely tied, and then adjust our view to reflect the lack of data. S&P understands the Andorran government is actively working to address this deficiency, through the approval of a new Statistic Plan for 2018-2021 and a strengthening of the country’s statistical services.
