OREANDA-NEWS. Fitch Ratings has affirmed the Autonomous Community of Catalonia's (Catalonia) Long-Term Foreign and Local Currency Issuer Default Ratings (IDRs) at 'BB' with Negative Outlooks. Fitch has also affirmed the Short-Term Foreign Currency IDR at 'B'. The ratings on the senior unsecured outstanding bonds have been affirmed at 'BB'.

The affirmation reflects continued political uncertainty in light of the provisional executive power in Spain and Catalonia. Fitch assumes the Regional Liquidity Fund (FLA) will continue to support Catalonia's debt obligations in 2016. The Negative Outlook reflects the potential outcome of either an abrupt separation from Spain or the withdrawal of state support over the medium term, as well as Catalonia's weak budgetary performance, growing debt and liquidity risk.

KEY RATING DRIVERS

Political Tension Unresolved

Political uncertainty continues to prevail over the region, after the President of Catalonia called for a motion of confidence next September, following the rejection by CUP, a far left wing party, of the budget presented by the new ruling party Junts Pel Si (JxS, centre-right wing).

At the national level, a fragmented parliament resulting from the June 2016 general elections means further delays in forming a new executive. Fitch believes that the process for Catalonia's independence is likely to remain uncertain until stable national and regional governments have been formed.

Catalonia's regional parliament in November 2015 passed a resolution to formally start the process for independence from the rest of Spain, which the Constitutional Court subsequently suspended at the request of the central government. The relationship between Catalonia and the central government is no longer co-operative, in Fitch's view, having led to the agency's downgrade of the region in November 2015 (See "Q&A on the Rating Floor for Spanish Regions" dated 23 December 2015 on www. fitchratings. com).

Debt Redemption Supported

Fitch is monitoring the assistance the central government is providing Catalonia through the FLA in the region's redemption of EUR5,921m long-term debt in 2016. This includes EUR2,863m from state liquidity mechanisms. Fitch assumes these obligations will be serviced willingly by Catalonia and on a timely basis. An additional EUR4,627m in short-term debt will fall due in 2016, which will be rolled-over by Catalonia under the oversight of the Ministry of Finance and Public Administration (MinHap). Fitch believes MinHap's monitoring, the availability of treasury advances and the coverage of these maturities by FLA as a last resort mitigate the liquidity risk. However, evidence of weakening state support may result in a negative rating action.

Catalonia is a major recipient of state liquidity support. Fitch estimates Catalonia will borrow at least EUR8bn from the FLA in 2016, so that borrowing from the central government will amount to around EUR45bn, close to 70% of Catalonia's expected total debt.

Weaker-than - Expected Performance

Catalonia's budgetary performance has been weak, with negative current balances since 2009. The region's 2015 preliminary results showed a negative current margin of 21.6%, which is below Fitch's expectations. Deficit before debt was EUR6.7bn, worse than Fitch's expectations of EUR5bn, mostly driven by the recognition of EUR1.3bn of public-private partnership obligations from previous years after a change to the accounting rules by MinHap. Catalonia breached the 0.7% fiscal deficit goal in 2015, posting a 2.7% deficit.

Following the roll-over of the 2015 budget, authorised expenditure in 2015 is prevented from increasing in 2016. We expect budgetary performance to improve in 2016, due to higher revenues from the funding system in 2016 (EUR2bn), higher expected tax collection, and lower interest expenses (by EUR0.9bn) after the restructuring of the state loans. However, Catalonia is unlikely to meet the 0.7% fiscal deficit target in 2016, and volatile performance is possible given the region's recent budgetary track record.

We expect debt growth to slow slightly on the back of higher revenues, with debt representing 300% of current revenue at end-2016, down from 308% in 2015.

Regional Economy Growing

Catalonia has an above-average economic profile, and is recovering more quickly than the national economy. Nominal GDP grew 3.9% against 3.8% nationally in 2015, and the unemployment rate was 17.4% in the 1Q16, versus 21% in Spain. Moreover, the total number of unemployed in Catalonia decreased 12.9% yoy in 1Q16, versus a 12% decline nationwide. Although the economic recovery has not been affected by the current political uncertainty, a unilateral independence of Catalonia is likely to result in economic shock.

RATING SENSITIVITIES

Fitch will continue to monitor developments in Catalonia and may take negative rating action if state liquidity support weakens. If the political environment normalises, Fitch may reinstate the Support Rating Floor of 'BBB-' for Catalonia.

KEY ASSUMPTIONS

Fitch assumes that the region will continue to have access to state support for debt servicing over the medium term.