Spain’s Credit Rating Cut by S&P Amid Concern Europe Debt Crisis Worsening

Spain’s credit rating was cut for the third time in three years by Standard & Poor’s as slowing growth and rising defaults threaten banks and undermine efforts to contain Europe’s sovereign-debt crisis.

The ranking was reduced by one level to AA-, S&P’s fourth- highest investment grade, with the outlook remaining negative, the rating company said in a statement late yesterday. Fitch Ratings downgraded Spain to the same level on Oct. 7, when the company also cut its rating on Italy.

“Despite signs of resilience in economic performance during 2011, we see heightened risks to Spain’s growth prospects,” S&P said. “The financial profile of the Spanish banking system will, in our opinion, weaken further, with the stock of problematic assets rising further.”

Spanish, Italian and Greek bonds fell on concern that the euro region is struggling to contain a crisis that threatens to trigger another global slump. As Group of 20 finance ministers prepare to meet in Paris, G-20 and International Monetary Fund officials indicated that the IMF may seek additional funds to shelter nations such as Spain and Italy from contagion.

Investors’ focus is 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 issue is “whether austerity plans will work,” he said.

Spanish Stocks

Spanish stocks fell, with the main Ibex 35 index (IBEX) declining 0.5 percent at 9:15 a.m. in Madrid. Europe’s Stoxx 600 Index and the euro were little changed.

Spain’s 10-year bond yield rose to 5.26 percent from 5.21 percent yesterday. Spain is paying more than twice what Germany pays to borrow for a decade even after the European Central Bank stepped in to prop up its bond market on Aug. 8.

In another sign of stresses on banks, UBS AG, Lloyds Banking Group Plc and Royal Bank of Scotland Group Plc had their long-term issuer default grades cut by Fitch Ratings, which put more than a dozen other lenders on watch negative as part of a global review. Greece is teetering on the brink of default, with Nobel economics laureate Christopher Pissarides saying yesterday that investors in its bonds may face losses of 50 percent.

Moody’s Investors Service warned on Oct. 4 that “all but the strongest euro-area sovereigns are likely to face sustained negative pressure on their ratings,” as it cut Italy’s debt for the first time in almost two decades.

U.S. Rating

The ratings move on Spain comes two months after S&P stripped the U.S. of its AAA ranking for the first time. While the Aug. 5 move roiled global markets, bond investors ignored S&P’s warnings about U.S. creditworthiness and piled into Treasuries. The yield on the benchmark U.S. government bond fell to a record 1.6714 on Sept. 23.

The downgrade also comes as the government postponed until after the Nov. 20 general election the sale of management contracts for Madrid and Barcelona airports, following the decision last month to pull an initial public offering of the state lottery operator. Privatizations had been expected to cut debt issuance by as much as 12 billion euros this year, Finance Minister Elena Salgado said on Aug. 16.

IMF War Chest

Policy makers are discussing an expansion of the IMF’s firepower as part of a global G-20 agreement next month in Cannes, France, according to three officials, who declined to be named because the discussions are not public. Talks are in preliminary stages as potential contributors wait to see what measures Europeans take to end the debt turmoil at an Oct. 23 summit, they said.

IMF Managing Director Christine Lagarde told member countries last month that her current $390 billion war chest may not suffice to meet all loan requests should the global economy worsen. Additional funds could be used to help shelter Italy and Spain with precautionary lending, the people said.

Spain’s Socialist government, facing an election next month, has said the country may miss its 2011 growth forecast of 1.3 percent as the recovery slows. Unemployment rose to 21.2 percent in August and the manufacturing industry contracted the most in more than two years in September. Regional governments, which are responsible for health and education and hire half of Spain’s public workers, are behind schedule to meet deficit targets, preliminary data showed Sept. 8.

‘Strong Signal’

The People’s Party, which polls indicate may win an outright majority in the vote, has pledged a stricter budget law, spending limits for regional governments, and tax breaks to encourage companies to hire workers and become more competitive. PP leader Mariano Rajoy said on Sept. 15 he would send a “strong signal” to markets and wouldn’t deviate from the budget-deficit goal of 4.4 percent of gross domestic product in 2012 “under any circumstances.” He hasn’t given details on how he would rein in the shortfall.

Still, the PP voted against Zapatero’s measures to cut public wages and freeze pensions, and has pledged to bring pensions “up to date” if it wins the election. Zapatero’s austerity measures aim to slash the shortfall to 6 percent of GDP this year from 11 percent in 2009. The government forecasts the debt burden will grow to 67 percent of gross domestic product this year, almost twice the 36-percent level in 2007.

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

To contact the editors responsible for this story: Fergal O’Brien at fobrien@bloomberg.net; Craig Stirling at cstirling1@bloomberg.net; Stephanie Phang at sphang@bloomberg.net

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