Moody's Places Spain's Aa2 Rating On Downgrade Review
Just to make sure that we all get the message that a consolidated sell off across all asset classes is what the cental planning doctor ordered, here comes Moody's to not only trim all the gains in the EURUSD since the Boehner debacle, but to remind us that the Fourth Reich is coming, even as the US of Aa- still struggles to pass its 2009 budget. Oh, and as a reminder Moody's put Italy's Aa2 rating on downgrade review on June 17, which means the formal downgrade is due right... about.... now.
Moody's places Spain's Aa2 ratings on review for possible downgrade
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 rating.
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 governments.
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 2010 onwards.
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.
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