Spanish Deficit Haunts Rajoy Defying Junk Status

Spanish Prime Minister Mariano Rajoy’s results from his first year in office are about to get a close inspection by credit rating companies and investors.

Deficit data due this month will show how far the government reduced its budget shortfall in 2012, a year when Spain came close to needing a bailout. While 10-year borrowing costs are down more than 200 basis points from their July peak, two ratings companies grade Spanish bonds one level above junk and another cut may make them too risky for some investors.

“Spain’s budget deficit numbers are crucial,” said Harvinder Sian, a senior fixed-income strategist at Royal Bank of Scotland Group Plc in London, in a telephone interview. “A number near and certainly above 8 percent of gross domestic product in 2012 will raise the risk of a ratings downgrade, and while we expect near 7.5 percent, the regions have delivered late surprises in the last couple of years.”

With suspense on the deficit persisting, Rajoy will deliver a speech tomorrow in Madrid where he may defend the five rounds of spending cuts and tax increases inflicted on Spain last year. That austerity still failed to bring the shortfall below the European Commission’s target and the government might need to step up efforts to avoid missing its goal this year too.

Junk Threshold

Spain has recently enjoyed a respite from the ravages of the debt crisis, shielded by European Central Bank President Mario Draghi’s pledge to do whatever it takes to defend the euro, and his creation of a bond-buying weapon to enforce it. Ten-year bond yields rose 6 basis points to 5.42 percent at 2:18 p.m. in Madrid, compared with a euro era high of 7.75 percent before Draghi’s comments in July.

The country’s bonds are rated Baa3 at Moody’s Investors Service and BBB- at Standard & Poor’s, each at the lowest threshold of investment grade. Fitch Ratings has a BBB grade on Spain, one level higher. While investors often ignore ratings, evidenced by the rally in Treasuries after the U.S. lost its top grade at S&P in 2011, a reduction to junk might threaten Spain’s access to some buyers of its debt.

“A downgrade to a non-investment grade would be a serious blow,” said RBC Capital Markets head of European rates strategy Peter Schaffrik. “There are a large number of accounts that simply wouldn’t hold Spain anymore, leading to higher yields.”

Deficit Forecasts

Fitch affirmed Spain’s rating on Feb. 8 with a negative outlook. Both other ratings companies declined to say when they might next comment on its creditworthiness. Moody’s confirmed its rating on Oct. 16 with a negative outlook, and said last month that Spain faces risks to its prospects for growth and budget-deficit reduction that are “large and overwhelmingly to the downside.” S&P last cut Spain’s rating in October.

Economists surveyed in January by Bloomberg forecast a deficit of 8 percent of GDP for last year, which matches the prediction of the European Commission and is worse than the original goal of 6.3 percent. The Commission is due to update its forecasts on Feb. 22, after estimating in November that Spain’s deficit will reach 6 percent of GDP in 2013, against a goal of 4.5 percent.

Spain has missed every budget goal set by the European Union since 2009, when its deficit peaked at 11.2 percent of GDP. Replacing his Socialist predecessor in late 2011 as the economy succumbed to a recession, Rajoy imitated him by cutting public wages and increasing value-added tax a second time, exacerbating the slump. Unemployment has reached a record 26 percent and the International Monetary Fund predicts a 1.5 percent economic contraction in 2013.

Montoro Report

Budget Minister Cristobal Montoro is due to release 2012 data at some point in the coming days or weeks. That will include statistics on the tax-funded pensions and jobless-benefits system, whose deficit is expected by officials to reach 1 percent of GDP for last year, 10 times that of 2011.

The Commission’s next recommendations for Spain will be published in May, after EU statistics agency Eurostat releases the first of its bi-annual government debt and deficit estimates in April, EU spokesman Simon O’Connor said in a telephone interview. EU budget enforcer Olli Rehn signaled Jan. 28 he might seek to ease austerity prescriptions for Spain.

Economists, including Ricardo Santos at BNP Paribas SA, said there’s a risk the Eurostat report in April may show a deficit much worse than Montoro’s data.

Bills Backlog

“Deficit data revision risks remain for 2012 as well as 2011,” David Haugh, head of the Spain desk at the Paris-based Organization for Economic Co-operation and Development, said in a telephone interview.

Data revisions might be exacerbated by public authorities’ backlog of bills to suppliers. Montoro this month pledged more measures to force municipalities and regions to pay arrears.

“As long as suppliers go unpaid, it shows spending isn’t under control and it’s impossible to guarantee there aren’t more bills lying in drawers,” said Maria Yolanda Fernandez Jurado, associate tenured professor of the Faculty of Economic and Business Sciences at Madrid’s Universidad Pontificia Comillas. “In the meantime, it creates dangerous uncertainty among investors.”

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