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.
These were the main reasons for placing the ratings of the Kingdom of
Spain under review on 29 July 2011 and the key areas that Moody's
considered during the review period. Since that time, funding
challenges for sovereign-related credits as well as uncertainties
about the specifics of future euro area support, and about near-term
economic growth (and hence the likelihood of further deficit reduction)
have increased rather than abated. The credit strengths,
on the other hand, have been largely unchanged.
Today's rating action on Spain follows Moody's recent rating
actions on the sovereign ratings of Italy (A2, negative outlook)
and Belgium (Aa1, rating on review for possible downgrade),
which were driven by similar concerns.
Moody's is maintaining a negative outlook on Spain's rating
to reflect the downside risks from a potential further escalation of the
euro area crisis. The rating agency expects that the next government
to emerge after Spain's parliamentary elections on 20 November will
be strongly committed to continued fiscal consolidation. Spain's
rating would face further downward pressure if this expectation did not
materialise. On the other hand, the implementation of a decisive
and credible medium-term fiscal and structural reform plan coupled
with a convincing solution to the euro area crisis would trigger a return
to a stable outlook.
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-à-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.
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.
Moody's has today also downgraded the rating of Spain's Fondo de
Reestructuración Ordenada Bancaria (FROB) to A1 with a negative
outlook, in line with the sovereign rating action. The FROB's
debt is fully and unconditionally guaranteed by the government of Spain.
FROB's Prime-1 short-term rating is unaffected by
today's rating action.
RATIONALE FOR DOWNGRADE
The first driver of Moody's decision to downgrade Spain's
sovereign rating is the continued vulnerability of Spain to market stress
and, as a result, to elevated funding costs and event risk.
Moody's believes that, even if policy action at the euro area
level were to succeed in the short term in returning some degree of normality
to bank and sovereign debt markets in the euro area, the underlying
fragility and loss of confidence is deep and likely to be sustained.
High debt and/or deficit countries with large annual funding needs are
thus considerably more susceptible to event risk in the form of a loss
of market access at affordable rates. Moody's believes that
these event risks are better reflected by ratings within the A category
rather than the Aa category (see also Moody's recent Special Comment
on "Rating Euro Area Governments Through Extraordinary Times --
An Updated Summary" for a broader assessment of the euro area sovereign
rating outlook). Nonetheless, Moody's points out that
Spain's new A1 rating reflects its view that the risk of default
by Spain remains remote. While the Spanish sovereign can sustain
higher funding costs for an extended period, the impact on liquidity
and funding conditions for regional governments and the banking sector
is more severe, with negative implications for the economic outlook.
The weakened growth outlook is the second driver for Moody's rating
action. While GDP forecasts for 2011 were already very moderate,
the rating agency has now reduced its forecast for 2012 to a real GDP
growth rate of only 1%, down from 1.8% previously.
The risks to this growth forecast are to the downside. Moody's
acknowledges that the necessary rebalancing of the economy is progressing,
with positive signs from the export sector. Spain's trade
balance with the EU is in surplus for the first time since records began,
and international competitiveness is gradually being recovered through
lower labour cost increases than in key competitor countries. However,
the necessary adjustment of the economy will likely take several more
years, and, in the short term, the slowdown in Spain's
key export markets will negatively affect growth. This is already
evident in the moderation of export growth over the past several months
compared to earlier in the year. The situation on the labour market
is severe and will remain so unless further reforms are enacted.
The banking sector continues to be fragile as the difficult funding and
economic conditions put further pressure on asset quality and profitability.
House prices are expected to decline further. At the same time,
Moody's acknowledges that the Spanish authorities have made progress
with the restructuring of the weak parts of the banking system.
Thirdly, the more moderate growth prospects in turn complicate the
already difficult outlook for Spain's public finances. In
particular, Moody's expects that the regional governments
as a whole will miss this year's deficit target of 1.3%
of GDP by a full percentage point of GDP. While the rating agency
acknowledges that most of the regional governments are now adopting expenditure-focused
fiscal adjustment policies, Moody's points out that achieving
the deficit targets would require a significant acceleration of the cost-cutting
measures. In June 2011, Moody's had already warned
about fiscal slippage among Spain's regional governments,
not only for the remainder of 2011 but also in 2012 (see Moody's
Special Comment entitled "Spanish Regions: Continued Fiscal
Slippage Would Have Negative Ratings Impact").
Despite the additional fiscal measures implemented by the central government
in August (amounting to approx. 0.3% of GDP),
it will be difficult for the central government to fully compensate for
the deviation by the regional governments. Moody's expects
the budget deficit for the general government sector to amount to 6.5%
of GDP in 2011, half a percentage point above the government's
target for the year. For 2012, the rating agency expects
a deficit of 5.2% of GDP (revised upwards from 4.8%
of GDP previously), well above the government's commitment
to reduce the deficit to 4.4% of GDP. This forecast
already includes substantial adjustments in most discretionary and mandatory
expenditure categories.
PRINCIPAL METHODOLOGY
The principal methodology used in this rating was Sovereign Bond Ratings
published in 2008. Please see the Credit Policy page on www.moodys.com
for a copy of this methodology.
REGULATORY DISCLOSURES
For ratings issued on a program, series or category/class of debt,
this announcement provides relevant regulatory disclosures in relation
to each rating of a subsequently issued bond or note of the same series
or category/class of debt or pursuant to a program for which the ratings
are derived exclusively from existing ratings in accordance with Moody's
rating practices. For ratings issued on a support provider,
this announcement provides relevant regulatory disclosures in relation
to the rating action on the support provider and in relation to each particular
rating action for securities that derive their credit ratings from the
support provider's credit rating. For provisional ratings,
this announcement provides relevant regulatory disclosures in relation
to the provisional rating assigned, and in relation to a definitive
rating that may be assigned subsequent to the final issuance of the debt,
in each case where the transaction structure and terms have not changed
prior to the assignment of the definitive rating in a manner that would
have affected the rating. For further information please see the
ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.
The rating has been disclosed to the rated entity or its designated agent(s)
and issued with no amendment resulting from that disclosure.
Information sources used to prepare the rating are the following :
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Kathrin Muehlbronner
Vice President - Senior Analyst
Sovereign Risk Group
Moody's Investors Service Ltd.
One Canada Square
Canary Wharf
London E14 5FA
United Kingdom
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Bart Oosterveld
MD - Sovereign Risk
Sovereign Risk Group
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Moody's downgrades Spain's government bond ratings to A1, negative outlook
