It’s that time again. 11pm in Madrid, which can only mean a downgrade of the Spanish sovereign, this time by Moody’s.
It’s a double-notch downgrade, taking Spain to A1 with negative outlook, using Moody’s schematic. S&P and Fitch both rate Spain at AA-, one notch higher than Moody’s, although the ratings are not directly comparable. Moody’s currently rates Italy at A2, with negative outlook, one notch below Spain.
The main reasons are straightforward: no eurozone debt solution, poor growth prospects (Moody’s gives up on Spain seeing 2 per cent growth any time soon) and the consequent difficulty in meeting fiscal targets. From the release:
Moody’s downgrades Spain’s government bond ratings to A1, negative outlook London, 18 October 2011 —
Moody’s Investors Service has today downgraded Spain’s government bond ratings to A1 from Aa2. This rating action concludes the review for possible downgrade that Moody’s had initiated for Spain’s rating on 29 July. The ratings carry a negative outlook.
The main drivers that prompted the rating downgrade are as follow:
(1) Spain continues to be vulnerable to market stress and event risk. Since placing the ratings under review in late July 2011, no credible resolution of the current sovereign debt crisis has emerged and it will in any event take time for confidence in the area’s political cohesion and growth prospects to be fully restored. In the meantime, Spain’s large sovereign borrowing needs as well as the high external indebtedness of the Spanish banking and corporate sectors render it vulnerable to further funding stress.
(2) The already moderate growth prospects for Spain have been scaled back further in view of (i) the worsening global and European growth outlook and (ii) the difficult funding situation for the banking sector and its impact on the wider economy. Specifically, Moody’s now expects Spain’s real GDP growth in 2012 to be 1% at best, compared with earlier expectations of 1.8%, with risks mainly to the downside. Over the following years, the rating agency continues to expect a very moderate pace of growth of around 1.5% on average per annum.
(3) Lower economic growth in turn will make the achievement of the ambitious fiscal targets even more challenging for Spain. Moody’s expects the budget deficits for the general government sector to be above target both this year and next. In particular, Moody’s continues to have serious concerns regarding the funding situation of the regional governments and their ability to reduce their budget deficits according to targets.
But it’s the supplementary reasons for downgrade that are especially interesting — and worrying for the next Spanish government (parliamentary elections take place on 20 November). Moody’s argues, for example, that Spain is different from double-A sovereigns for several reasons, which are emphasised below:
In Moody’s view, Spain’s sovereign rating is more adequately placed in the A rating category than the Aa category given the potential for contagion from further shocks and the domestic fragilities. Long-term economic strength — a key input into Moody’s sovereign methodology — is no longer considered to be very high but only moderate given the expectation of a lengthy economic rebalancing process. Moody’s also notes that most sovereign issuers with a Aa3 rating have much stronger fiscal and external positions than Spain, including very low public debt, sound public finances and a net creditor status vis-a-vis the rest of the world. This constellation renders them far less vulnerable to a confidence-driven funding crisis than Spain. At the same time, Moody’s acknowledges that Spain has significant fundamental credit strengths when set against its close peers.
However, there is hope:
Even when accounting for the missed deficit targets, Spain’s public debt ratio will likely peak at around 75% of GDP, implying a lower vulnerability to growth and interest rate shocks than some of its lower rated peers. Despite a slow start, there is now a clear track record of policy action in Spain which encompasses not only fiscal consolidation but also labour market and pension reforms as well as recapitalisation of the weak parts of the banking sector. The recent constitutional amendment which was supported by the main opposition party is a clear indication that there is a broad consensus on the need for further fiscal consolidation. Despite the downward rating action, Moody’s notes that the risk of a default by Spain is remote.