From S&P: "The deepening economic recession is limiting the Spanish government's policy options. Rising unemployment and spending constraints are likely to intensify social discontent and contribute to friction between Spain's central and regional governments. Doubts over some eurozone governments' commitment to mutualizing the costs of Spain's bank recapitalization are, in our view, a destabilizing factor for the country's credit outlook."
S&P adds: "We are therefore lowering our long- and short-term sovereign credit ratings on Spain to 'BBB-/A-3' from 'BBB+/A-2'. 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 eurozone policy."
Complete S&P Rationale
The downgrade reflects our view of mounting risks to Spain's public finances, due to rising economic and political pressures. The central government's policy responses are likely to be constrained by:
A severe and deepening economic recession that could lead to increasing social discontent and rising tensions between Spain's central and regional governments;A policy setting framework among the eurozone governments that in our opinion still lacks predictability. Our understanding from recent statements is that the eurogroup's commitment to break the vicious circle between banks and sovereigns, as announced at a summit on June 29, does not extend to enabling the European Stability Mechanism to recapitalize large ongoing European banks. Our previous assumption (which was a key factor in our decision to affirm our ratings on Spain on Aug. 1, 2012) was that official loans to distressed Spanish financial institutions would eventually be mutualized among eurozone governments and thus Spanish net general government debt would remain below 80% of GDP beyond 2015.
In our view, the capacity of Spain's political institutions (both domestic and multilateral) to deal with the severe challenges posed by the current economic and financial crisis is declining, and therefore, in accordance with our rating methodology (see "Sovereign Government Rating Methodology And Assumptions," published June 30, 2011), we have lowered the rating by two notches.With local elections approaching and many regional governments facing significant financial difficulties, tensions between the central and regional governments are rising, leading to substantially diluted policy outcomes.
These rising domestic constraints are, in our view, likely to limit the central government's policy options.
At the same time, Spain is enduring a severe and, in our view, deepening economic recession as reflected in our real GDP forecast of -1.8% in 2012 and -1.4% in 2013
In our opinion, the 2013 state budget is based on overly optimistic growth assumptions (government real GDP forecast of -0.5%). Fiscal targets are likely to be undermined by a continuous decline in employment, as well as the government's proposal to possibly index pensions before year-end 2012, and to raise them in 2013. In our view, meeting the government's deficit targets in 2012 and 2013 will require additional budgetary consolidation measures, which in turn could amplify the economic recession, particularly if a more determined eurozone policy response is unable to materially improve the financing conditions in the economy and stabilize domestic demand.
Although we think the recently passed National Reform Program will ultimately help to strengthen the economic fundamentals and resilience of the Spanish economy, these benefits may only be felt over the long term. In fact, the current deterioration in economic and financial conditions could raise fiscal risks in the near-to-medium term before the growth enhancing structural reforms take root. Therefore, we view the Spanish government's hesitation to agree to a formal assistance program that would likely significantly lower the sovereign's commercial financing costs via purchases by the European Stability Mechanism and ECB as potentially raising the downside risks to Spain's rating (see "A Request For A Full Bailout Would Not Affect Spain's Sovereign Ratings, published Aug. 22, 2012).
Overall, against the backdrop of a deepening economic recession, we believe that the government's resolve will be repeatedly tested by domestic constituencies that are being adversely affected by its policies. Accordingly, we think the government's room to maneuver to contain the crisis has diminished.
The uncertain trajectory and timing of eurozone policy making is affecting business and consumer confidence--and hence the capacity of the Spanish economy to grow. A key outcome for Spain will be whether eurozone policies can contribute to stabilization in its domestic financial system in a timely manner, in particular by reversing the net outflow of funds in the economy experienced during 2011 and 2012. Following the audit of the banking sector, we believe that an improvement in financial conditions hinges in part on the resolve of policymakers to make progress on the integration of the eurozone, starting with the implementation of agreements reached at the summit on June 29. We believe implementing these agreements could help to stabilize the eurozone and contribute to arresting any further weakening in the creditworthiness of sovereigns in the so-called periphery.
We continue to view the governments, including Spain, that are receiving official assistance as vulnerable to delays or setbacks in the eurozone's plans for a support framework. This includes pooling sufficient common resources to support sovereign lending facilities and the creation of a banking union with a single regulator and a common resolution framework. In this light, our current net general government debt projections reflect our assumption that official loans to distressed Spanish financial institutions will eventually fall on the government balance sheet and project Spanish net general government debt will reach about 83% of GDP in 2013.
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