Spain’s debt rating was cut to one level above junk by Standard & Poor’s, which cited euro-region peers’ backtracking on a pledge to severe the link between the sovereign and its banks as it considers a second bailout.
The country was lowered two levels to BBB- from BBB+, New York-based S&P said in a statement yesterday. S&P assigned a negative outlook to the nation’s long-term rating and lowered the short-term sovereign level to A-3 from A-2.
The downgrade comes after Spain announced a fifth austerity package in less than a year and published details about stress tests of its banks. Creditworthiness concerns have grown since the government requested as much as 100 billion euros ($129 billion) in European Union aid in June to shore up its lenders and amid signals that the deficit target is in jeopardy.
S&P said the government’s action will probably be constrained by “a policy-setting framework among the euro-zone governments that still lacks predictability.” Recent statements on the European Stability Mechanism’s involvement in bank recapitalizations put into question the mutualization of loans to Spanish banks among euro-region nations, it said.
That possibility was a key factor in S&P’s decision to affirm ratings on Spain on Aug. 1 as it would enable Spanish net general government debt to remain under 80 percent of gross domestic product beyond 2015, it said.
The yield on Spain’s 10-year benchmark bond jumped as much as 12 basis points to 5.93 percent today before dropping to 5.80 percent at 12:09 p.m in Madrid, compared with a record of 7.75 percent on July 25, a day after Spain signed a memorandum of understanding awarding it a credit line for its banks.
The spread with similar German maturities widened 2 basis points to 4.33 percentage points while the euro was little changed at $1.2882, after weakening as much as 0.4 percent to $1.2826, the lowest since Oct. 1.
AAA-rated countries Germany, the Netherlands and Finland issued a joint statement on Sept. 25 saying the ESM should only be used to recapitalize banks as a last resort. They also ruled out its taking direct responsibility for problems that occurred before the new supervision.
Spanish Economy Minister Luis de Guindos told reporters on Oct. 9 after meeting with peers in Luxembourg that the issue of those legacy assets hadn’t been discussed. Meanwhile, German Finance Minister Wolfgang Schaeuble called the debate a “phantom” and said a transfer of legacy bailouts isn’t compatible with firewall-fund agreements.
Lack of Clarity
The rating cut was unexpected and is negative for Spain, said Ignacio Fernandez-Palomero Morales, the deputy head of the nation’s Treasury. The downgrade was based on a lack of clarity in the resolution plan for the debt crisis, he said today at a conference in Tokyo.
Investors are shunning Spanish securities as Prime Minister Mariano Rajoy weighs a second bailout amid a deepening recession. Rajoy has held off on a decision about whether to request European Central Bank and EU bond buying to lower borrowing costs. He’s called for more details on what would be demanded of Spain in return for the support.
Deputy Economy Minister Fernando Jimenez Latorre today told reporters in Madrid he expects an intervention on secondary markets may take place shortly, while saying Spain still requires information before it can make a decision.
“One can expect that one way or the other, the mechanism of intervention on secondary markets starts to act relatively soon,” Latorre said. “If the ECB itself considers there are inefficiencies in the transmission of monetary policy and that there are doubts on the irreversibility of the euro project, it is logical to think that European institutions will take the necessary measures shortly to dissipate those doubts.”
A “deepening economic recession that could lead to increasing social discontent and rising tensions between Spain’s central and regional governments” adds to risks, S&P said. “The negative outlook on the long-term rating reflects our view of the significant risks to Spain’s economic growth and budgetary performance, and the lack of a clear direction in euro-zone policy.”
Spain’s economy, suffering its second recession since 2009, will probably shrink 1.3 percent next year after a 1.5 percent contraction in 2012, the International Monetary Fund forecasts.
The IMF’s managing director, Christine Lagarde, told Bloomberg Television yesterday that the fund doesn’t need to lend money to Spain to help the country tackle its fiscal crisis. The IMF is helping monitor a 100 billion-euro bailout of Spanish banks.
Spain’s financing needs are increasing along with its costs. It plans to borrow 207.2 billion euros next year, pushing its debt load to almost 91 percent of economic output as the state absorbs the cost of rescuing banks and the power system. The rate was 36 percent in 2007, before a 10-year real-estate boom ended, derailing public finances.
This year’s budget gap will be 7.4 percent of GDP, Budget Minister Cristobal Montoro said on Sept. 29. Even so, Spain’s 6.3 percent target will be met because it can exclude the cost of the bank rescue, he said. Spain’s deficit was the third largest in the euro area last year, at 8.96 percent of GDP.
S&P’s decision brings Spain a step closer to a non-investment grade two years since it lost its top AAA grade. Spain is rated one level above junk by Moody’s Investors Service at Baa3, and two levels higher by Fitch Ratings, which has Spain at BBB.
The junk rating may put additional pressure on Spain’s banks by reducing the value of the government bonds that they use as collateral to access funding from the ECB.
Even so, analyses done by ratings firms on the world’s biggest nations have been an unreliable indicator of investor sentiment over the past year.
France’s 1.08 trillion euros of debt maturing in a year or more has rallied 8.6 percent since it was downgraded to AA+ on Jan. 13, more than double the gains for the rest of the global government bond market, and beating AAA-rated Germany, the U.K. and Australia, according to Bank of America Merrill Lynch indexes. U.S. borrowing costs also tumbled after the biggest economy was stripped of its AAA credit grade in August 2011.