Spain, Italy Set for Downgrade Amid Slump, Citigroup Says

Spain and Italy will be downgraded by Moody’s Investors Service and Standard & Poor’s this year as the recession and debt crisis worsen, economists and strategists at Citigroup Inc. said.

Their credit ratings, along with those of Ireland and Portugal, will be lowered at least one level over the next two to three quarters, Citigroup said in a report published late yesterday. “Deficits will overshoot official forecasts in all the peripheral Economic Monetary Union countries this year and in 2013,” according to the report.

“Spain will need to enter some form of a Troika program” this year, Citigroup economists including London-based Juergen Michels wrote, referring to the aid package for Greece monitored by the European Union, the European Central Bank and the International Monetary Fund. Prime Minister Mariano Rajoy has repeatedly said that Spain won’t need a bailout.

The warning comes amid a flare-up of Europe’s debt crisis. Investor confidence in the debt of Europe’s so-called peripheral countries has eroded since Spain’s announcement on March 2 that it won’t meet its deficit target this year, helping to push up bond yields. Yesterday, Italy also delayed its goal to balance the budget by one year to 2014.

Previous Action

Both countries were put on negative outlook by Moody’s on Feb. 13, when the rating firm downgraded six European nations, including Italy to A3 from A2 and Spain to A3 from A1. A month earlier, Standard & Poor’s cut the ratings of nine euro states, with Spain lowered to A from AA- and Italy to BBB+ from A, both with negative outlooks.

Citigroup expects a “two-notch downgrade of the Spanish sovereign later this year by S&P and a one-notch downgrade by Moody’s” as well as a further one-level reduction by both rating companies over the longer term. That would put Spain “at the lower end of the investment grade spectrum, reflecting the fact that whatever Troika program enters, it is likely to retain some form of market access for medium- and long-term issuance.”

Spain, which has passed about 40 billion euros of spending cuts and tax rises since December, is also contracting amid the highest jobless rate in Europe. Rajoy’s government forecasts the economy will shrink 1.7 percent this year with unemployment holding above 24 percent.

Budget Blow

Last Month, Rajoy announced his government wouldn’t keep a vow to cut the deficit to 4.4 percent in 2012 and would instead post a shortfall of 5.8 percent. Under pressure from European partners, he later agreed to reduce it to 5.3 percent.

The yield on Spain’s 10-year benchmark bond has increased by about 1 percentage point since March 2 to 5.9 percent at 4:57 p.m. Madrid time. Italy has fared better, its 10-year yield rising to 5.57 percent from 4.9 percent.

Prime Minister Mario Monti’s drive to overhaul Italy’s economy, mired in its fourth recession since 2001, risks foundering over opposition to his plan to revamp the labor market. He also faces rising discontent as Italians chaff under the effects of 20 billion ($26 billion) in austerity measures, with brought higher taxes and gasoline prices that have reached a record of almost 2 euros a liter, or $10.50 a gallon.

By year-end, Italy may be downgraded one level to BBB by S&P and to Baa1 by Moody’s, as the economy probably shrinks more than the government’s forecasted contraction of 1.2 percent for 2012, the Citigroup analysts said.

“The falling public support for Monti in opinion polls suggests that the government will have increasing difficulties in going ahead with the implementation of structural reforms,” according to the report. Over the next two to three years, “we expect Italy’s rating by S&P to go down by two notches in total and to settle at BBB- and its Moody’s rating to go down by three notches to settle at Baa3.”

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