Moody's downgrades Spain's debt rating

[March 10, 2011]  LONDON (AP) -- Moody's downgraded its credit rating on Spain Thursday, citing worries over the cost of the banking sector's restructuring and the government's ability to achieve its borrowing reduction targets.

The agency said it was reducing its rating by one notch to Aa2 and warned that a further downgrade could be in the offing if there are indications that Spain's fiscal targets will be missed and if the public debt ratio increases more rapidly than currently expected, or if the funding requirements for the so-called savings banks -- the cajas -- are greater than anticipated.

Though noting the government's resolve in dealing with its problems and that Spain's debt sustainability is not under threat, Moody's said that "Spain's substantial funding requirements -- not only those of the sovereign, but also those of the regional governments and the banks -- make the country susceptible to further episodes of funding stress."

One of the main motivations behind the downgrade was Moody's expectation that the eventual cost of recapitalizing the cajas will be much more than the government's current projections. While the government reckons the cost will be a maximum of euro20 billion ($27.8 billion), or less than 2 percent of Spain's gross domestic product, Moody's thinks the likely cost will be near euro40-50 billion and could eventually come in at a massive euro100-120 billion.

The Spanish government is trying to get a handle on its borrowings by reducing spending and raising taxes. The expectation in the markets is that the country managed to reduce its budget deficit from over 11 percent of national income in 2009 to around 9 percent last year.

However, it's doing all this at a time when unemployment remains elevated above 20 percent, following the collapse of a property and construction boom that sent the economy skidding into a two-year recession.

The big worry in the markets is that Spain will get sucked into Europe's debt crisis, which has already seen Greece and Ireland get financial bailouts from their partners in the EU and the International Monetary Fund. Portugal is widely expected to be next.

Most analysts think that the EU can contain the government debt crisis, even if Portugal is forced to tap a bailout fund. However, Spain would be a different kettle of fish and could test the limits of the existing bailout fund -- the European Financial Stability Facility, or EFSF -- potentially putting the euro project itself in jeopardy if governments don't put up more cash.

"It remains essential that the EFSF is bolstered to reassure markets that there is enough ammunition to protect monetary union against all eventualities," said Jane Foley, senior currency strategist at Rabobank International.

Earlier this week, Moody's Investor Services cut its rating on Greece too, prompting a sharp tirade from the Greek government about the role of credit rating agencies.

The downgrades have come amid signs that Europe's debt crisis is flaring up again ahead of the March 24-25 summit of EU leaders in Brussels. Portugal's cost to borrow 10-year bonds is standing near a euro-era record.

Though a "comprehensive solution" to the debt crisis has been trumpeted, there are growing fears that the 17 countries that use the euro will not agree a revamped bailout mechanism, set new rules on budget deficits and a system of support funds to flow from richer countries in the single currency bloc to the poorest.

Moody's had put Spain on notice for a downgrade in December.

[Associated Press; By PAN PYLAS]

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