Moody’s Says Spain’s Credibility on Public Finances Is Weakening

Spain’s failure to honor budget-deficit goals has hurt the country’s credibility and justifies a negative outlook on the sovereign’s credit rating, Moody’s Investors Service said.

“The continued deviations from agreed budgetary targets as well as the repeated revisions of budget-deficit outcomes are weakening the credibility of the Spanish government in the area of public finance,” Moody’s analysts Kathrin Muehlbronner and Bart Oosterveld wrote in a report published today.

At the same time “Spain’s fiscal performance has improved materially in 2012 compared to 2011,” they said. “This was achieved against the background of a weakening economy and is therefore a positive step towards placing the country’s public finances on a sustainable path.”

Moody’s has a Baa3 rating on Spain, the lowest investment grade. Standard & Poor’s rates the country BBB-, the same level, while Fitch Ratings holds it at BBB, two levels above junk. Investors often ignore ratings, evidenced by the rally in Treasuries after the U.S. lost its top grade at S&P in 2011.

Spain, the euro area’s fourth largest economy, is due to submit its mid-term budget plans to the European Commission by the end of the month and Prime Minister Mariano Rajoy has asked it to ease the country’s budget-deficit goals to help lift the economy out of a six-year slump.

Deficit Targets

Spain’s current deficit targets are 4.5 percent of gross domestic product for 2013 and 2.8 percent for 2014. That compares with overspending of 10.2 percent of GDP last year, or 7 percent excluding aid to the banking sector.

Moody’s calculates the cost of bank recapitalizations added an amount equivalent to 3.65 percent of output to Spain’s budget gap last year.

Muehlbronner and Oosterveld expect the deficit to reach about 6 percent of GDP this year as public sector employees’ Christmas bonus won’t be scrapped again and pension expenditure has increased by more than 5 percent a year on average over the past five years.

In 2014, a modest return to growth may reduce the deficit to as low as 5 percent of GDP if temporary tax increases introduced last year are maintained, according to the report.

Regarding Spain’s 17 semi-autonomous regions, they said “the continuing accumulation of commercial debt signals persistent liquidity tensions in the regional sector despite the sizable state liquidity support provided in 2012.”

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