Andorra’s first-time external bond market issuance diversifies funding beyond domestic sources and extends the average maturity of the government’s debt, reducing refinancing risks, Fitch Ratings says.
Andorra (BBB+/Stable) issued a 10-year EUR500 million Eurobond with a 1.25% coupon on 28 April. The issue was almost five times oversubscribed and attracted broad international investor interest, in line with the government’s strategy to widen its funding sources.
Before the Covid-19 pandemic, the government had only tapped domestic financing sources. Andorra has fairly high domestic financing flexibility, given that bank holdings of government debt are only 2%-3% of total banking sector assets and demand from domestic retail investors appears strong.
However, an overreliance on domestic financing risks creating a negative feedback loop between the sovereign and the banking system in an economic or financial shock.
The 10-year bond has also significantly lengthened Andorra’s average debt maturity to 5.1 years from 2.2 years, substantially lowering the government’s rollover requirement. Reliance on domestic financing sources has limited the average debt maturity, especially as the government targeted retail investors (46% of debt holdings as of mid-2020), who have traditionally preferred shorter-dated investments.
As a result, we expect gross borrowing requirements in 2022 to be exceptionally high at EUR665 million, or 23.9% of GDP, as five government bonds mature and we expect the government to continue running a fiscal deficit (borrowing will cover EUR615 million in maturing debt plus a EUR50 million general government fiscal deficit).
The Eurobond should not change Andorra’s average cost of debt and could help reduce it in the medium term by locking in favourable pricing, depending on the composition of other borrowing. Andorra’s effective interest rate on debt stood at 1.3% in 2020 and its longest outstanding bond (five-year maturity) carries a coupon of 1.75%.
The increase in external debt will cause the sovereign net foreign asset position to deteriorate, projected at -20.3% of GDP this year from a balanced position pre-pandemic. In Fitch’s view, external financing risks are mitigated by the country’s use of the euro as legal tender, the same currency in which its external debt is denominated.
Andorra’s Euro Medium-Term Note programme amounts to EUR1.2 billion (46% of GDP), allowing the government to tap the markets again this year or in 2022. However, we do not expect general government debt/GDP to increase beyond our current projections of 47.9% of GDP in 2021 and 45.8% in 2022, given the authorities’ intention to use Eurobond proceeds for general budgetary purposes and debt repayment.
Before the pandemic, Andorra maintained low and stable general government fiscal surpluses, averaging 1.9% of GDP since 2010. As a result, the general government debt burden at 35.4% of GDP in 2019, 6.6pp lower than the ‘BBB’ category median, provided fiscal space to effectively counter the effects of the pandemic on the Andorran economy.
Reallocation of spending and a very targeted approach to supporting the economy resulted in a fairly small fiscal deficit last year, at 4% of GDP (‘BBB’ median at 6.2% of GDP). This record gives us confidence that the government will stabilise the debt burden this year and return it to a downward trajectory over the medium term.
The pandemic still presents risks to our fiscal projections. Prolonged mobility restrictions at Andorra’s borders have severely affected its tourism-depended economy during the lucrative skiing season.
To mitigate the impact on domestic demand, the government extended its financial support to the tourism sector, with wage and rent subsidy schemes extended from March until end-May. The government has yet to announce whether the increase in Covid-19 spending w be offset with expenditure rationalisation.
