Spain’s Debt Downgraded by S&P as Slump Swells Budget

By Emma Ross-Thomas

Jan. 19 (Bloomberg) -- Spain had its AAA sovereign credit rating removed by Standard & Poor’s in the second downgrade of a euro-region government in five days, as the country’s first recession in 15 years swelled the budget deficit.

The risk of losses on Spanish government debt rose to a record, credit-default swaps showed, after S&P lowered the rating one step to AA+ and assigned it a “stable” outlook. It was S&P’s first reduction in Spain’s rating and puts it on the same level as Belgium and Hong Kong.

The cost of economic stimulus packages and bank bailouts is boosting budget deficits around the euro-region, fueling concern governments will have difficulty paying their debt. S&P cut Greece’s rating one step to A- on Jan. 14. A day earlier, it threatened to downgrade Portugal’s debt. S&P also reduced the outlook on Ireland’s rating to negative from stable.

“The only country that should be able to keep its AAA rating is Germany,” said Jose Carlos Diez, chief economist in Madrid at Intermoney SA, Spain’s largest bond dealer. “There should be a question mark over the rest.”

Spain’s economy, whose growth outpaced the euro region for more than a decade, entered a recession in the second half of last year as the credit crisis fueled the collapse of a debt- fueled housing boom, sending the unemployment rate to the highest in Europe. The government has announced about 90 billion euros ($119 billion) of stimulus measures and steps to support banks amid a decline in tax revenue.

Rising Risk

Credit-default swaps on Spain’s debt rose 5 basis points to a record 137 today, BNP Paribas SA prices at 11:30 a.m. in London showed. Credit-default swaps, conceived to protect investors from default, pay the buyer face value in exchange for the underlying securities or the cash equivalent should a company fail to adhere to its debt agreements. An increase signals a deterioration in the perception of credit quality.

“Current economic and financial market conditions have highlighted structural weaknesses in the Spanish economy that are inconsistent with a AAA rating,” a team of analysts at S&P led by Trevor Cullinan in London wrote in a statement today.

The extra yields, or spreads, between some European countries’ debt and that of Germany have widened to records amid the fallout from the global economic turmoil. The spread between 10-year Spanish notes and German bunds narrowed 4 basis points after today’s S&P announcement to 1.15 percentage points.

Debt to GDP

The European Commission expects Spain’s economy to shrink 2 percent this year and another 0.2 percent in 2010.

Spain’s debt was equivalent to 36 percent of gross domestic product in 2007, compared with 66 percent for the euro zone and 95 percent for Greece, according to data compiled by Bloomberg. It will amount to 47 percent of GDP this year, rising to around 51 percent next year and between 53 percent and 54 percent in 2011, Finance Minister Pedro Solbes said on Jan. 16.

The government should reduce its debt-to-GDP ratio and liberalize labor and product markets to improve competitiveness, S&P said today. The rating may be cut again if budget deficits remain in place too long, it said. The downgrade also affects the debt of government-controlled companies including Instituto de Credito Oficial, according to S&P.

Nations that have been downgraded from AAA before include Japan, Sweden, Finland and Denmark, according to S&P.

To contact the reporter on this story: Emma Ross-Thomas in Madrid at erossthomas@bloomberg.net.