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Ratings On Spain Lowered To 'BBB+/A-2' On Debt Concerns; Outlook Negative

Publication date: 26-Apr-2012 21:55:43 BST

  • We believe that the Kingdom of Spain's budget trajectory will likely deteriorate against a background of economic contraction in contrast with our previous projections.
  • At the same time, we see an increasing likelihood that Spain's government will need to provide further fiscal support to the banking sector.
  • As a consequence, we believe there are heightened risks that Spain's net general government debt could rise further.
  • We are therefore lowering our long- and short-term sovereign credit ratings on Spain to 'BBB+/A-2' from 'A/A-1'.
  • 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 impact we believe this will likely have on the sovereign's creditworthiness.
NEW YORK (Standard & Poor's) April 26, 2012--Standard & Poor's Ratings 
Services today said it lowered its long-term sovereign credit rating on the 
Kingdom of Spain to 'BBB+' from 'A'. At the same time, we lowered the 
short-term sovereign credit rating to 'A-2' from 'A-1'. The outlook on the 
long-term rating is negative.

Our transfer and convertibility (T&C) assessment for Spain, as for all 
European Economic and Monetary Union (EMU or eurozone) members, is 'AAA', 
reflecting Standard & Poor's view that the likelihood of the European Central 
Bank (ECB) restricting non-sovereign access to foreign currency needed for 
debt service of non-euro obligations is low. This reflects the full and open 
access to foreign currency that holders of euro currently enjoy and which we 
expect to remain the case in the foreseeable future.

The downgrade reflects our view of mounting risks to Spain's net general 
government debt as a share of GDP in light of the contracting economy, in 
particular due to:

  • The deterioration in the budget deficit trajectory for 2011-2015, in contrast with our previous projections, and
  • The increasing likelihood that the government will need to provide further fiscal support to the banking sector.

Consequently, we think risks are rising to fiscal performance and flexibility, 
and to the sovereign debt burden, particularly in light of the increased 
contingent liabilities that could materialize on the government's balance 

These concerns have led us to conclude a two notch downgrade is warranted in 
accordance with our methodology (see "Sovereign Government Rating Methodology 
And Assumptions," June 30, 2011).

Under our revised base-case macroeconomic scenario, which we view as 
consistent with the downgrade and the negative outlook, we have lowered our 
forecast for GDP to contract in real terms by 1.5% in 2012 and 0.5% for 2013. 
We had previously forecast real GDP growth of 0.3% in 2012 and 1% in 2013. 

We believe that negative drags on GDP include:

  • Declining disposable incomes;
  • Private-sector deleveraging;
  • Implementation of the government's front-loaded fiscal consolidation plan; and
  • The uncertain outlook for external demand in many of Spain's key trading partners.

In our opinion, the Spanish economy is rebalancing, and the measures the 
government has taken should facilitate this process. Spain's current account 
deficit (CAD) is on a narrowing trajectory, significantly supported by the 
Spanish economy's strong export performance, especially since 2009. The CAD 
was 3.5% of GDP at year-end 2011, compared with 10.0% in 2007. Excluding the 
income deficit, the current account is in balance. The income deficit, which 
reflects net interest and dividend payments on Spain's net liabilities to the 
rest of the world, widened in 2011 on the back of increased external funding 
costs. We expect the current account to broadly balance in 2013-2014, before 
posting a higher surplus thereafter. In contrast to 2008-2010, the Bank of 
Spain--through Target2 overdrafts with the ECB (exceeding €250 billion in 
March 2012, from around €150 billion at the end of 2011)--has now become the 
major source of financing Spain's CAD. In our opinion, this reflects the 
extent to which Spain's commercial banking system has sharply increased its 
dependency on official funding sources to a considerably higher level than we 
anticipated in January, when we last revised our rating on Spain (see "Spain's 
Ratings Lowered To 'A/A-1'; Outlook Negative," Jan. 13, 2012). 

Despite the unfavorable economic conditions, we believe that the new 
government has been front-loading and implementing a comprehensive set of 
structural reforms, which should support economic growth over the longer term. 
In particular, authorities have implemented a comprehensive reform of the 
Spanish labor market, which we believe could significantly reduce many of the 
existing structural rigidities and improve the flexibility in wage setting. 
Even if, in our opinion, the reform is unlikely to eliminate the structural 
duality in the Spanish labor market, we believe it will ultimately benefit 
employment growth once a sustainable recovery sets in. In the near term, 
increased labor market flexibility is likely to accelerate the necessary wage 
adjustment and reduce the pace of job-shedding. At the same time, we do not 
believe the labor reform measures will create net employment in the near term. 
As a consequence, the already high unemployment rate--especially among the 
young--will likely worsen until a sustainable recovery sets in. 

Financial sector reform, announced in February 2012, requires banks to 
allocate additional loan loss provisions and raise capital buffers on exposure 
to real estate developments and construction projects. We believe these 
sectors will continue to be the main sources of asset quality deterioration. 
The reform has also led to further banking sector consolidation. Recent 
acquirers have benefited from asset protection schemes, with potential losses 
covered by a partial (80%) guarantee provided by the Deposit Insurance Fund to 
absorb future credit losses from the acquired banks' legacy portfolios. We 
estimate that the guarantees related to these schemes, combined with those 
that will likely be provided in the upcoming sale of three entities currently 
controlled by the Fondo de Reestructuracion Ordenada Bancaria (FROB), 
represent a contingent liability for the sovereign in the amount of about 
3.75% of GDP. Combined with embedded risks in the rest of the banking sector, 
public enterprises, and other state guarantees, we now estimate contingent 
fiscal risks to the sovereign as moderate, as defined in our criteria (see "
Sovereign Government Rating Methodology And Assumptions," published June 30, 

We believe the ECB's recent long-term repurchase operations (LTROs) have 
significantly reduced the risks the Spanish banking sector faced in 
refinancing its medium-term external debt and its short-term interbank 
liabilities maturing in the first half of 2012. The LTRO also helped banks to 
finance their government debt portfolios cheaply. Nevertheless, we do not view 
the provision of liquidity support by the monetary authorities as a substitute 
for financial sector restructuring and economic rebalancing. 

In our view, the strategy to manage the European sovereign debt crisis 
continues to lack effectiveness. We think credit conditions, and hence the 
economic outlook for Spain, could now deteriorate further than we anticipated 
earlier this year unless offsetting eurozone policy measures are implemented 
to support investor confidence and stabilize capital flows with the rest of 
the world. Such measures at the eurozone level could include a greater pooling 
of fiscal resources and obligations, possibly direct bank support mechanisms 
to weaken the sovereign-bank links, and a consolidation of banking supervision 
or a greater harmonization of labor and wage policies.

In light of the rapid rise in public debt since 2008, we expect the Spanish 
government to implement a sustained budgetary consolidation effort--including 
strengthening fiscal surveillance frameworks at the regional government 
level--aimed at gradually reducing the government's net financing needs. 
Balancing this commitment to stabilizing public finances with policymakers' 
clear interest in preventing an acceleration of the economic downturn will be 
challenging in the absence of fiscal transfers from abroad, or private-sector 
credit creation at home. At the same time, we believe front-loaded fiscal 
austerity in Spain will likely exacerbate the numerous risks to growth over 
the medium term, highlighting the importance of offsetting stimulus through 
labor market and structural reforms.

Following budgetary slippage of 2.5% of GDP in 2011 beyond the 6.0% target, 
the government has committed to a target of 5.3% of GDP in 2012 and 3.0% in 
2013. In our opinion, these targets are currently unlikely to be met given the 
economic and financial environment. We forecast a budget deficit of 6.2% of 
GDP in 2012 and 4.8% in 2013 (our previous forecasts were 5.1% and 4.4%). We 
also believe the delay to adopting the 2012 budget could reduce the 
government's capacity to prevent deviations from its budget plans.

Given the significant and regular budgetary slippages at the regional 
level-–the main contributor to the deviations from the government's 
targets--the national government's willingness to fully enforce its new budget 
will likely be tested as we expect the regions to post a shortfall of around 
0.4% of GDP in 2012, above their 1.5% of GDP 2012 target. Because of 
higher-than-previously-expected deficit projections, and other debt-increasing 
items such as arrears resolutions (estimated at 3.9% of GDP in 2012), we 
forecast net general government debt at 76.6% of GDP in 2014, against our 
previous projection of 64.6% of GDP. State guarantees to the European 
Financial Stability Fund, the European Stability Mechanism, and the 
Electricity Deficit Amortization Fund, which are included in the government's 
own debt projections, are not part of our debt estimate and are instead 
classified with other state guarantees. 

In line with the increasing risks we see to Spain's recovery, we have also 
considered a downside scenario that, if it were to eventuate, could lead us to 
lower the ratings again. This downside scenario assumes a deeper recession in 
Spain this year, as a result of weaker external and domestic demand, with real 
GDP declining by 4% in real terms, followed by a contraction of 1% in 2013 and 
a weak recovery thereafter. Under this downside scenario, the current account 
would adjust faster, but the general government deficit trajectory would 
deteriorate further. The net general government debt ratio would breach 80% of 
GDP. For details for all our scenarios, see our analysis on Spain.

The negative outlook reflects our view of the significant external and 
domestic risks to Spain's economic growth and budgetary performance, and the 
impact we believe this may have on the sovereign's creditworthiness.

We could lower the ratings if we were to see a rise in net general government 
debt to above 80% of GDP during 2012-2014, reflecting fiscal deviations, 
weakening growth, or the crystallization of contingent liabilities on the 
government's balance sheet beyond our current projections. We could also 
consider a downgrade if political support for the current reform agenda were 
to wane. Moreover, we could lower the ratings if we see that Spain's external 
position worsens or its competitiveness does not continue to approach that of 
its trading partners, a key factor for Spain to return to sustainable economic 
and employment growth. 

We could revise the outlook to stable if we see that risks to external 
financing conditions subside and Spain's economic growth prospects improve, 
enabling the net government debt ratio to stabilize below 80% of GDP. 

Complete ratings information is available to subscribers of RatingsDirect on 
the Global Credit Portal at All ratings affected 
by this rating action can be found on Standard & Poor's public Web site at Use the Ratings search box located in the left 
column.  Alternatively, call one of the following Standard & Poor's numbers: 
Client Support Europe (44) 20-7176-7176; London Press Office (44) 
20-7176-3605; Paris (33) 1-4420-6708; Frankfurt (49) 69-33-999-225; Stockholm 
(46) 8-440-5914; or Moscow 7 (495) 783-4009.
Additional Contact:Sovereign Ratings;

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