The European debt crisis deepened as the credit ratings of Spain and Cyprus were downgraded by Moody’s Investors Service.
Moody’s yesterday cut Spain’s rating three steps to Baa3, one level above junk, from A3, citing the nation’s increased debt burden, weakening economy and limited access to capital markets. Moody’s also lowered Cyprus’s bond rating to Ba3 from Ba1, attributing the downgrade to the material increase in the likelihood of a Greek exit from the euro area, and the resulting increase in the probable amount of support that the government may have to extend to Cypriot banks.
Moody’s is following the sentiment of financial markets that weren’t calmed by Europe’s 100 billion-euro ($126 billion) weekend bailout of Spanish banks, said Clay Lowery, a vice president at Washington-based Rock Creek Global Advisors LLC and former assistant Treasury secretary for international affairs.
For Moody’s, “it’s not whether you’re going to make money off your investment, it’s what is the creditworthiness of the borrower,” Lowery said. “Spain’s debt load has gotten larger with much more senior debt, so at least the potential for them to default has now gone up.”
Rifts are deepening with Greek elections on June 17 risking the first exit from the single currency as voters buckle under the continent’s most-severe austerity program. Spanish bond yields reached a record after the nation’s request for aid for its banks fueled speculation the world’s 12th-biggest economy may need a full rescue.
The key reason for the downgrade “is obviously the need of Spain’s government to ask for external help,” Kathrin Muehlbronner, a London-based senior analyst with the sovereign group at Moody’s, said in a telephone interview. “In our view, that’s not a sign of strength, it’s a sign of weakness.”
Spain is on review for further downgrade as it plans to borrow 100 billion euros from European Union rescue funds to recapitalize its banking system, adding to the government’s debt load, New York-based Moody’s said yesterday in a statement. Spanish Prime Minister Mariano Rajoy requested the rescue on June 9.
U.S. Treasury Secretary Timothy F. Geithner spoke yesterday as Spain was downgraded. Spain’s bailout “is a good, concrete signal and illustration” of Europe’s commitment to move toward a “broader banking union,” Geithner said. He said a more integrated banking system is “important because of the pressures you’re seeing from Greece and elsewhere.”
The euro rallied for a third day today, rising 0.2 percent to $1.2586 as of 1:55 p.m. in Tokyo.
The Group of 20 nations will meet in Los Cabos, Mexico, June 18-19 to discuss the European debt crisis. A U.S. official said yesterday the leaders probably won’t announce significant progress on Europe’s debt crisis. Geithner will attend along with President Barack Obama.
The summit in Los Cabos will give European leaders a chance to discuss economic concerns with heads of other major economies. European governments are more focused on building a consensus for a summit they are holding later in the month, the official told reporters on condition of anonymity.
The meeting in Mexico comes after Greece votes on June 17. The Syriza party, led by Alexis Tsipras, has promised to abrogate the terms of the 240 billion-euro ($302 billion) bailout from the European Commission, European Central Bank and International Monetary Fund, which calls for cuts that risk deepening the country’s worst recession since World War II.
Yields on Spanish debt due in 10 years climbed to 6.75 percent yesterday, compared with 5.1 percent at the end of last year. The Spanish rate has jumped more than 50 basis points since the nation agreed to the bailout package for its banks. Italy has also seen borrowing costs surge and today will hold its first bond auction since the rescue in Spain.
“Investors are worried about putting their money into those markets for fear that they might eventually follow the same path as Greece,” Shane Oliver, the Sydney-based chief economist and head of investment strategy at AMP Capital Investors Ltd., said about Spain and Italy in an interview with Bloomberg Television. “Particularly given that the Spanish bank bailout likely entails those investors taking a subordinate position to the bailout fund.”
Spanish Deputy Economy Minister Fernando Jimenez Latorre said yesterday that Spain will stick to the tools it has used so far to shore up its banks, rejecting calls from Finland, one of the euro region’s six AAA rated sovereigns, to break up failing lenders.
“The Spanish government has very limited financial market access,” Moody’s said in the statement, citing the nation’s need for rescue funds and “its growing dependence on its domestic banks as the primary purchasers of its new bond issues, who in turn obtain funding from the” European Central Bank.