Spain's Prime-1 short-term ratings are unaffected by today's action
New York, July 29, 2011 -- Moody's Investors Service has today placed Spain's Aa2 government
bond ratings on review for possible downgrade. Spain's Prime-1
short-term ratings are unaffected by today's action.
The initiation of the ratings review is driven by the following concerns:
1.) The continued funding pressures facing the Spanish government,
which the precedent set for future euro area support arrangements by the
official package for Greece is likely to exacerbate, and the resulting
increase in risks to bondholders.
2.) The challenges posed to the government's fiscal consolidation
efforts by the weak growth environment and the continued fiscal slippage
among several regional governments.
Funding costs have been rising for some time for the Spanish government
and for many closely related debt issuers, such as domestic banks
and regional governments. Pressures are likely to increase still
further following the announcement of the official package for Greece,
which has signalled a clear shift in risk for bondholders of countries
with high debt burdens or large budget deficits. The package has
not relieved market concerns over the position of such sovereigns because
(i) it sets a precedent for private sector participation in future sovereign
debt restructurings in the euro area, and (ii) while an expansion
of powers has been proposed for the EFSF, it is not clear when the
powers will be implemented.
Moody's views positively that the central government has been successful
in meeting its near-term fiscal consolidation targets, but
the rating agency nonetheless notes that challenges to long-term
budget balance remain due to Spain's subdued economic growth and
fiscal slippage within parts of its regional and local government sector.
Moody's review will evaluate the weight of these risks, set
against the Spanish government's high Aa2 rating and its credit
strengths, which include (i) a low public debt ratio compared to
other highly rated EU sovereigns; (ii) its success in achieving budget
targets for 2010; and (iii) its implementation of key structural
reforms, including progress made in the recapitalization of the
banking system. Moody's will also evaluate the outlook for
economic growth against the high debt levels of the private sector and
the need for an ongoing rebalancing of the economy.
Moody's has today also placed the Aa2 rating of Spain's Fondo de
Reestructuración Ordenada Bancaria (FROB) on review for possible
downgrade as the FROB's debt is fully and unconditionally guaranteed
by the government of Spain.
In the absence of any unexpected development, Moody's expects
that any change in the rating following the review is most likely to be
limited to one notch.
The announcement of the rating review closely follows the publication
of two Moody's Special Comments, which explain why the official
support package for Greece has negative credit implications for non-Aaa-rated
euro area sovereigns with high debt burdens or large budget deficits,
and why the fiscal under-performance of several Spanish regional
governments has adverse credit implications for Spain's sovereign
RATIONALE FOR REVIEW
The main driver of Moody's decision to place Spain's sovereign
rating on review for possible downgrade is the increased vulnerability
of the Spanish government's finances to market stress and consequently
to elevated funding costs and event risk. Funding costs have in
fact been rising for some time for the Spanish government and for many
closely related debt issuers, such as domestic banks and regional
Moody's ratings are not affected by short-term market moves;
however, the risk of a sustained rise in funding costs nevertheless
has to be factored into the agency's analysis of a country's
prospective debt affordability. While the likelihood of a shift
in sentiment that would prevent a country with Spain's fundamental
strength from accessing private financing on affordable terms remains
low, the risk of such a shock has risen in recent months.
Moreover, the official support package for Greece announced last
week somewhat increases the potential for adverse market dynamics given
(i) the precedent it sets for possible private sector participation in
the future provision of support for euro area member states, and
(ii) the uncertainties surrounding the content of the package, including
whether the EFSF will be expanded and when the promised expansion in the
scope of its powers will be implemented. As Moody's stated
earlier this week, the official support package for Greece has negative
credit implications for non-Aaa-rated euro area sovereigns
with large debt burdens and/or high deficits, (See Moody's
Special Comment entitled "EU Support Package Permits Orderly Default
by Greece and Buys Time, But Credit Effects Are Mixed for Other
Euro Area Sovereigns", published 25 July 2011). Moody's
will factor this into its risk analysis for such euro area sovereigns.
The review of Spain's sovereign rating is consistent with this objective
and follows Moody's rating action on Italy, whose Aa2 sovereign
rating was placed on review for possible downgrade on 17 June 2011,
in part to reflect similar concerns.
The second driver underlying Moody's review is its continued concern
over the central government's ability to ensure compliance by regional
governments with fiscal targets, especially given the limited effectiveness
of the central government's debt authorization powers. (See
Moody's Special Comment entitled "Spanish Regions: Continued
Fiscal Slippage Would Have Negative Ratings Impact", published
28 June 2011.) Moody's expects the regional governments to
miss their collective budget deficit target by up to 0.75%
of GDP, which would make the achievement of the overall budget target
for the general government sector (deficit of 6% of GDP in 2011)
more difficult. The rating agency expressed concern that regional
governments' finances may prove difficult to control due to structural
spending pressures, particularly in the healthcare sector.
FACTORS TO BE CONSIDERED IN THE REVIEW
Moody's review of Spain's credit rating will focus on both
external and domestic factors.
In terms of the external factors, Moody's review will largely
focus on the broader question of how best to reflect the impact of last
week's precedent-setting announcement of a Greek package
on funding pressures facing non-Aaa-rated euro area sovereigns
that are vulnerable to elevated market stress and loss of confidence,
be it due to the need to finance large budget deficits or to roll over
very high debt levels.
The impact of last week's euro area decisions on the depth,
breadth and price of Spain's market access and the risks borne by
its bondholders as a result will be an important factor in that assessment.
The package announced remains subject to uncertainties and execution risks.
Moody's review will therefore monitor progress in implementing the
expanded EFSF powers to support sovereign debt prices. It will
also assess the impact of the package's announcement on market dynamics
and on Spain's access to and the cost of private funding in the
medium term. Moody's notes that the Spanish Treasury has
already issued an important portion of its funding requirement for the
year at affordable interest rates, and should be able to accommodate
temporarily higher interest rates within its current budget parameters.
Spain's debt affordability ratio, defined as debt interest
payments as a share of total government revenues, is roughly in
line with that of Belgium and lower than that of Italy.
As for the domestic factors, Moody's will assess the likelihood
that the central government will again be able to compensate for fiscal
slippage at the regional government level. Any additional measures
at the regional government level, both to correct the fiscal slippage
currently evident and to address the structural spending pressures on
the regional finances, will also be assessed during the review period.
In this context, Moody's notes that the government was able
to achieve the target set for the general government budget deficit in
2010 (9.2% of GDP versus target of 9.3%),
and reduced its own central government deficit by a full percentage point
of GDP more than the target (5.7% of GDP versus target of
6.7%). At around 60% of GDP in 2010,
Spain's public debt ratio is lower than that of several important
European countries, including several Aaa rated sovereigns.
Judging from the budget execution for the year to June, the Spanish
government also seems to be on track to achieve its target for the current
year (central government deficit of 4.8% of GDP),
although Moody's believes that budget execution will probably deteriorate
in the remainder of the year due to higher interest rates paid from May
Moody's also notes that the Spanish economy has so far grown broadly
in line with the agency's baseline assumptions. The necessary
rebalancing of the economy is progressing, with positive signs from
the export sector. Spain is -- next to the Netherlands and
Ireland -- the only euro area country that has managed to surpass
its previous peak level in exports, signaling stronger underlying
export dynamism than most of its peers. The key downside risk continues
to be the weakness of private consumption against the background of high
household debt, rising interest cost and persistently high unemployment.
The recently implemented changes to the collective bargaining system are
widely considered to be inadequate to significantly increase urgently
needed flexibility in the labour market. GDP data for Q2,
to be published at the end of August, should give further clarity
on the outlook for the economy.
PREVIOUS RATING ACTION AND METHODOLOGY
Moody's last rating action affecting Spain was taken on 10 March
2011, when the rating agency downgraded Spain's government
bond ratings to Aa2 and assigned a negative outlook. The rating
action prior to that was taken on 15 December 2010, when the rating
agency placed Spain's Aa1 ratings on review for possible downgrade.
Moody's last rating action affecting FROB was implemented on 10 March
2011, when the rating agency downgraded the FROB's rating
to Aa2 and assigned a negative outlook. This action followed the
same rating action on the government of Spain, which provides a
full guarantee on the senior unsecured debt issued by FROB.
The principal methodology used in rating the government of Spain is Moody's
"Sovereign Bond Methodology", published in 2008,
which can be found at www.moodys.com.
Vice President - Senior Analyst
Sovereign Risk Group
Moody's Investors Service, Inc.
MD - Sovereign Risk
Sovereign Risk Group
Moody's Investors Service, Inc.
Moody's Investors Service, Inc.
Moody's places Spain's Aa2 ratings on review for possible downgrade
250 Greenwich Street
New York, NY 10007