Moody's warns it may downgrade Spain's debt

[December 15, 2010]  MADRID (AP) -- Ratings agency Moody's on Wednesday warned it may downgrade Spain's debt because the government is vulnerable to a borrowing crunch next year, when the recapitalization of weak banks could prove more costly than expected for public finances.

The agency, which lowered Spain's rating from Aaa to Aa1 in September, says it will review the rating again because of high financing needs in 2011 but does not expect the country to need a bailout.

The government's bond yields have risen to high levels in recent weeks amid Europe-wide debt market turmoil. Investors fear that countries like Spain or Portugal will have trouble handling heavy debt loads and require emergency help, like Greece or Ireland.

Spain is considered a risk because it is still struggling to emerge from nearly two years of recession, has the highest unemployment rate in the eurozone and a swollen deficit.

Madrid's main stock index fell nearly 2 percent in morning trading after the report. Pressure also increased on Spain's 10-year bonds, with yields up 0.07 percentage points to 5.6 percent. That puts the yield 2.6 percentage points higher than the benchmark German 10-year bond -- still below the euro-era record difference of 3.05 percentage points hit earlier this month.

The government has continually denied it will need aid, stressing reforms and austerity measures will bring it through the crisis.

Commenting on the report in Parliament, Finance Minister Elena Salgado said she "hopes that before three months we can provide sufficient arguments to make that negative prospect positive."

Rating agencies normally conclude their reviews within three months.

In its statement Wednesday, Moody's Investors Service said it "does not believe that Spain's solvency is under threat," and does not expect the government will have to ask for European Union help.

"However, Spain's substantial funding requirements, not only for the sovereign but also for the regional governments and the banks, make the country susceptible to further episodes of funding stress. This is one of the drivers behind the review for possible downgrade," said Kathrin Muehlbronner, the agency's lead analyst for Spain.

Moody's stressed "that it continues to view Spain as a much stronger credit than other stressed Euro zone countries. This is reflected in the significantly higher rating for the Spanish sovereign. Moody's review will therefore most likely conclude that Spain's rating will remain in the Aa range."

The statement came two days after the ratings agency said it was keeping a negative outlook on Spanish banks because their capitalization, profitability and access to market funding are expected to remain weak amid Europe's unresolved financial crisis.

The agency expects the banks' credit conditions to be difficult for at least 12 months.

Spain's real estate sector, the economy's driving force for more than a decade, collapsed two years ago and many savings banks -- or "cajas" -- are now stuck with billions of euros in foreclosed property.

Many of these banks are being forced to merge under a consolidation process scheduled to finish this month.

Spain has also begun implementing austerity measures in a bid to slash a swollen deficit from 11.2 percent of GDP in 2009 to within the EU limit of 3 percent by 2013.

The country's third-quarter economic growth was flat after two quarters of weak growth, although it was up 0.2 percent year-on-year -- the first such rise in seven quarters.

[Associated Press; By CIARAN GILES]

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