Standard & Poor’s slashed Spain’s credit rating to AA-, three steps beneath the highly desirable AAA, underscoring the challenges facing Europe’s major powers as they meet G20 counterparts over the eurozone debt crisis. S&P, whose move mirrored that by fellow ratings agency Fitch, cited high unemployment, tightening credit and high private-sector debt. Spanish 10-year government bond yields climbed slightly in response, although they are still nearly 60 basis points lower than those of Italy.
“Despite signs of resilience in economic performance during 2011, we see heightened risks to Spain’s growth prospects due to high unemployment, tighter financial conditions, the still high level of private sector debt, and the likely economic slowdown in Spain’s main trading partners,” according to S&P. Spain’s Economy Minister Elena Salgado noted that there would be some margin for maneuver this year thanks to about two billion euros raised by an auction of wireless frequencies and lower interest payments. “Interest payments by the central government will be at least two billion euros below budget. So the combined effect of the spectrum auction and lower interest payments will mean we have a margin of 0.4 percent (of GDP)” Salgado said.
S&P took note of Spain’s “signs of resilience in economic performance during 2011” but saw “heightened risks” to the country’s prospects for growth. Elevated unemployment, tighter financial conditions, and an external debt-to-GDP ratio of approximately 50 percent and the likely economic slowdown of Spain’s main trading partners are the downgrade’s primary causes. S&P noted that the “economy” variable in its credit-rating equation was responsible for the downgrade. Spain’s GDP, according to S&P, will likely grow about 0.8 percent in 2011 and nearly one percent in 2012, weaker than S&P’s 1.5 percent estimate made in February. S&P said that Spain is still in danger of another downgrade if the situation deteriorates. According to their downside scenario, “We have also adopted a downside scenario, consistent with another possible downgrade. The downside scenario assumes a return to recession next year, partly as a result of weaker external and domestic demand, with real GDP declining by 0.5 percent in real terms, followed by a weak recovery thereafter. Under this downside scenario, the current account deficit would decline, but the general government deficit would remain above 5.5 percent of GDP, at odds with the government’s fiscal consolidation targets.”
Investors currently are focusing on“whether European governments can forge a political solution to the sovereign crisis,” said Guy Stear, Hong Kong-based credit strategist at Societe Generale SA. The longer-term question is “whether austerity plans will work,” he said.
S&P pointed out ongoing challenges facing Spain. “The financial profile of the Spanish banking system will, in our opinion, weaken further, with the stock of problematic assets rising further,” according to S&P analysts. Spain is being held back by “uncertain growth prospects in light of the private sector’s need to access fresh external financing to roll over high levels of external debt amid rising costs and a challenging external environment.”
Simon Denham, the head of Capital Spreads, noted that “S&P and Moody are working overtime at the moment downgrading bank after bank and European country after European country which reminds us of the dangerous situation that the eurozone is in. However, as mentioned, the overriding theme that something will be done to sort the mess out is keeping equity markets afloat and the FTSE remains just above the 5,400 level at the time of writing.”
Steven Barrow, currency strategist at Standard Bank, offers this perspective. “The move follows a similar downgrade from Fitch last week and hence does not have a huge shock factor for the market. Nonetheless, it clearly questions the markets ability to continue with the more optimistic tone towards the debt crisis that seems to have been reflected in the euro recently – although not necessarily in the bond markets.”
Catalina Parada, Marketing Consultant, is Alter NOW’s Madrid correspondent.