Spain Debt Outlook Cut by S&P as Slump Hurts Deficit (Update1)

Dec. 9 (Bloomberg) -- Spain had the outlook on its debt grade lowered by Standard & Poor’s as its public finances worsen, one day after Greece’s government bonds tumbled following a downgrade by Fitch Ratings.

S&P, which cut Spain from AAA to AA+ in January, said the country will experience a “more pronounced and persistent deterioration” in its budget and a “more prolonged period of economic weakness,” than it expected at the start of the year.

The outlook was lowered to “negative” from “stable” and that “reflects the risk of a downgrade within the next two years,” S&P said in a statement. The yield on the 10-year Spanish government bond rose 8 basis points to 3.83 percent, the highest since Nov. 23.

Bonds from Dubai to Greece have tumbled in the past two weeks on concerns that some governments will struggle to patch up their finances after the worst global recession since World War II. Greek 10-year government debt today slid for the fifth straight day as the European Union and other member states put pressure on the administration to rein in its deficit, set to be the highest in the EU this year at 12.7 percent of economic output.

Risk Premium

The extra interest, or spread, that investors demand to hold Spanish 10-year debt rather than German equivalents rose to 69.3 basis points from 60.7 basis points yesterday. European shares also fell on the S&P announcement as the Stoxx 600 index slid 1.3 percent to 240.96 at 3:33 p.m. in London. The Ibex-35 in Madrid declined 2.6 percent.

The situation in Greece “puts pressure on everyone,” said Harvinder Sian, a senior strategist at Royal Bank of Scotland Group Plc in London, who expects the Spanish spread to widen closer to that of Italy, which is currently 87 basis points.

“Ultimately they will be downgraded,” he said. “The government has to display that it’s getting serious.”

S&P said there is “time for the government to forge a political consensus supporting a credible fiscal consolidation.” “Concrete fiscal measures” that could produce primary surpluses of 2 percent may reduce downward pressure on the ratings, it said. The primary surplus excludes interest payments on debt.

Revenue Increases

The Spanish government plans to raise value-added tax next year and levies on income from capital and will rein in some stimulus spending, even as the economy is projected to continue to shrink. Spain doesn’t agree with the revision, and the announcement won’t affect policy as the government has already started taking steps to rein in the deficit, said a finance ministry official, who declined to be named in line with policy.

Spain’s budget deficit will be one of the widest in the euro region this year, at 11.2 percent of gross domestic product, according to the European Commission. The shortfall is expected to slip to 10.1 percent next year, and the government has until 2013 to bring it in line with the EU’s 3 percent limit. The debt burden is forecast to rise to 66 percent of GDP next year from 36 percent before the crisis in 2007, according to Commission data. That compares with a forecast of 84 percent for the euro area and 125 percent for Greece.

“Spain’s finances are in fundamentally much better shape than Greece; if one needs to worry about another country of the Eurozone, this is certainly more Ireland than Spain,” Luca Mezzomo, head of macroeconomic research at Intesa Sanpaolo in Milan.

Ireland, Portugal

Ireland lost its top credit rating this year in the first of two downgrades from S&P, and the government plans to cut spending to rein in the deficit. S&P put Greece’s debt on watch for a downgrade two days ago, and Fitch Ratings followed yesterday by cutting its credit rating one level from A- to BBB+. Portugal’s credit rating was also downgraded by S&P in January.

“I think rating pressure will remain for Greece, Spain, Ireland and Portugal for all the next year, so expect some more downgrades for sure,” said Chiara Cremonesi, a strategist at UniCredit Group in London.

Spain, which outgrew the euro region for a decade on the back of a debt-fueled housing boom, will continue to contract next year even as the euro area, the U.S. and the U.K. return to growth, according to the International Monetary Fund. Unemployment, already the highest in the euro region, will top 20 percent next year, according to the IMF forecasts, putting further pressure on the deficit.

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

To contact the editor responsible for this story: John Fraher at jfraher@bloomberg.net.