Spain Rating Cut for Third Time Since 2010

By Angeline Benoit and Sandrine Rastello - Oct 19, 2011 3:09 PM GMT+0700

Spain’s credit rating was cut for the third time in 13 months by Moody’s Investors Service as Europe’s debt crisis threatens to engulf the nation.

Moody’s yesterday reduced its ranking to its fifth-highest investment grade, cutting it by two levels to A1 from Aa2, with the outlook remaining negative. Standard & Poor’s downgraded Spain on Oct. 14 to its fourth-highest investment grade, and Fitch Ratings cut it to the same level on Oct. 7, the day it also downgraded Italy.

“Moody’s is maintaining a negative outlook on Spain’s rating to reflect the downside risks from a potential further escalation of the euro-area crisis,” it said in a statement. The company cited the “continued vulnerability of Spain to market stress” that is driving up the cost of borrowing, as well as weaker growth prospects. Spanish bonds fell.

Spanish and Italian bonds are being pummeled as European leaders fail to convince investors they can contain the debt crisis and shore up banks to withstand the risk of a Greek default. German Chancellor Angela Merkel said yesterday that an Oct. 23 European Union summit will mark an “important step,” though not the final one in solving the sovereign debt crisis.

‘Degree of Normality’

Spain’s 10-year bond yield rose to 5.38 percent today from 5.36 percent yesterday. Even as the European Central Bank has been propping up the bond market since August, Spain pays more than twice what investors demand of Germany to borrow for 10 years. That spread was 334 basis points today.

Spain’s Treasury said the decision wasn’t justified by the nation’s economic data and was more due to market tension over the euro crisis. Since Moody’s said in July any downgrade would likely be “limited to one notch,” the government has bolstered its credibility by including a budget-discipline clause in the constitution, the agency said in an e-mail obtained by Bloomberg News. Spain is committed to budget cuts and its bond auctions have proved “resilient,” it said.

“The Spanish Treasury believes that this rating action may be motivated more by a short-term reaction to negative news about the euro zone debt markets than by an analysis of Spain’s medium- and long-term fundamental outlook,” the note said.

European finance ministers and leaders are due to hold meetings in Brussels for three days through Oct. 23. Merkel cast doubt yesterday on the progress made in the run-up to the talks, telling reporters in Berlin that the weekend summit, while an “important step” that will make a “clear commitment” to defending the euro, will not be the last.

‘Underlying Fragility’

“Even if policy action at the euro-area level were to succeed in the short term in returning some degree of normality to bank and sovereign debt markets in the euro area, the underlying fragility and loss of confidence is deep and likely to be sustained,” Moody’s said.

A meeting of Group of 20 finance ministers and central bankers warned last week that the crisis threatens to endanger the world economy.

“It’s imperative that the Europeans do provide a comprehensive framework for addressing the crisis,” said Domenico Lombardi, a senior fellow at the Brookings Institution in Washington and a former International Monetary Fund board member. Failure to do so, he said, will result in a spiral of further downgrades and rising borrowing costs, “which will trigger a fully blown fiscal and banking crisis.”

New Government

Spain’s rating would face more downward pressure if the government formed after November elections doesn’t commit to further measures to reduce budget deficits, Moody’s said.

“On the other hand, the implementation of a decisive and credible medium-term fiscal and structural reform plan coupled with a convincing solution to the euro-area crisis would trigger a return to a stable outlook,” it said.

Spain’s Socialist government is set to lose the general election on Nov. 20, opinion polls indicate. The opposition People’s Party, which has pledged deeper austerity, changes to labor rules and an overhaul of banks, may win as many as 190 seats in the 350-seat assembly, a poll by El Pais newspaper showed on Oct. 16.

Spain, the fourth-largest euro-area economy, had the best investment grade possible with all three rating companies in January 2009, when Standard & Poor’s was the first to cut.

Moody’s said it had lowered its growth forecast for Spain to 1 percent “at best” in 2012, from a previous estimate of 1.8 percent, “with risks mainly to the downside.” Slower growth makes it harder to reduce budget deficits, especially with regional governments likely to miss their target, the company said.

Growth slowed to 0.2 percent in the second quarter and Prime Minister Jose Luis Rodriguez Zapatero said on Sept. 14 that the quarterly growth rate would remain at similar levels for the rest of the year. The budget deficit for the general government will reach 5.2 percent of gross domestic product next year, compared with an announced goal of 4.4 percent, Moody’s estimated.

To contact the reporters on this story: Angeline Benoit in Madrid at abenoit4@bloomberg.net; Sandrine Rastello in Washington at srastello@bloomberg.net

To contact the editor responsible for this story: Craig Stirling at cstirling1@bloomberg.net