Spain Faces Moody’s Downgrade Risk on Regions Budget Concern

Spain faces a possible downgrade by Moody’s Investors Service as its regions struggle to cut budget deficits and last week’s Greek bailout increases the risk that bondholders will have to pay for further European rescues.

Moody’s is reviewing the nation’s Aa2 classification, the ratings company said in a statement today. A cut would probably be “limited to one notch,” Moody’s said. The euro fell. Spain has the same credit rating as Italy, which is also on review for downgrade at Moody’s.

“This news is a blow to Europe’s efforts to contain the debt crisis to smaller countries like Greece or Portugal,” said Kornelius Purps, a fixed-income strategist at UniCredit SpA in Munich. “Rating downgrades, or any threat in this regard, do not gel with highly sensitive market sentiment.”

Spain, the euro region’s fourth-largest economy, is trying to rein in a surge in borrowing costs and convince investors it won’t follow Greece, Ireland and Portugal in seeking an international bailout. While European leaders on July 21 agreed to bulk up their rescue fund to set up a firewall around countries such as Spain, the yield on the country’s 10-year bond has again breached 6 percent after falling last week.

Moody’s also said it’s concerned that it will take too long for European officials to empower the 440 billion euros ($629 billion) fund so that it can buy government debt.

Bonds Drop

Spanish 10-year bonds fell for a third straight day, pushing the yield on the securities 4 basis points higher to 6.08 percent as of 10:13 a.m. in London. The additional yield investors demand to hold the securities instead of benchmark German bunds rose by eight basis points to 348 basis points. The euro slid 0.3 percent to $1.4285.

In its note, Moody’s said the last Greek rescue plan is likely to increase pressure on Spain as the package “has signaled a clear shift in risk for bondholders of countries with high debt burdens or large budget deficits” and because it is unclear when the bailout fund’s new powers will take effect.

“Challenges to long-term budget balance remain due to Spain’s subdued economic growth and fiscal slippage within parts of its regional and local government sector,” Moody’s said.

Clear Shift

Spanish Finance minister Elena Salgado, speaking on radio Onda Cero, said “Europe’s decisions at last week’s summit must be implemented more quickly” to reassure markets. “Spain is on the right path for fiscal consolidation,” she said, adding that “this is only a revision and Moody’s won’t take action” for another three months.

Spain’s Treasury told investors in a note obtained by Bloomberg News that the concerns expressed by Moody’s are “misplaced” because of the country’s low debt-to-gross domestic product ratio and its “very conservative” budgetary provisions for the interest rate burden.

“The government will continue to show the breadth and impact of the structural reforms in the financial, labor and product markets,” the Treasury said.

Prime Minister Jose Luis Rodriguez Zapatero, whose party faces elections by March, is implementing the deepest budget cuts in three decades while pushing lenders hit by real-estate losses to raise capital.

Unemployment Drop

Salgado pointed out the most recent data on unemployment is positive after second-quarter unemployment came in lower at 20.9 percent, compared with 21.3 percent in the first three months of the year. The central government will help Spain’s regions fund themselves, she said.

“Moody’s decision comes as a surprise because the latest data is positive,” said Estefania Ponte, the Madrid-based head of research at Cortal Consors. Spain is penalized by the delay in the implementation of the last Greek rescue plan, she said. “The market has been waiting for some time now for bond buy-backs to lessen the level of Greek debt.”

Salgado on July 27 secured an agreement with the nation’s 17 semi-autonomous regions on new budget rules, after first-quarter data showed the regions may miss their target of a 1.3 percent of gross domestic product deficit this year. The regions each committed to meet deficit targets of 1.3 percent in 2012, 1.1 percent in 2013 and 1 percent in 2014. Their outstanding debt of 121 billion euros, or 11 percent of overall GDP, is the most on record, Bank of Spain data show.

Moody’s also cut debt ratings of six Spanish regions by one level to reflect the “deterioration of their fiscal and debt positions.” Castilla-La Mancha, the central territory with Spain’s worst deficit, was cut to A3 from A2, while the northern region of Catalunya was lowered to Baa1 from A3. Five more regions were put under review, three of them for a downgrade.

The debt and deposit ratings of five Spanish banks were also placed on review by Moody’s. Lenders facing a possible downgrade are Banco Santander SA, CaixaBank, Banco Bilbao Vizcaya Argentaria SA, La Caixa and CECA.