Standard & Poor’s cuts Spain’s sovereign rating to just above junk status

Standard & Poor’s has lowered Spain’s sovereign credit rating to one notch above junk status, putting added pressure on the government of Prime Minister Mariano Rajoy to seek European assistance to lower its borrowing costs.

In a statement issued overnight Wednesday, the ratings agency said it had downgraded Spain’s long-term rating by two notches from BBB+ to BBB-. The outlook on the rating is negative. In its last review in August, S&P gave Spain a vote of confidence by leaving its ratings unchanged.

“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,” S&P said in its explanation for the downgrade.

“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 euro-zone policy,” the statement added.

Spain’s risk premium jumped to 448 basis points in early trade Thursday after closing Wednesday at 431 points. By midday it had eased to 436 basis points.

S&P warned of a “deepening economic recession that could lead to increasing social discontent and rising tensions between Spain’s central and regional governments.”

Regional elections are due to be held on October 21 in Galicia and the Basque Country, while Catalonia’s increasing financial difficulty has been one of the detonators behind the upsurge in the independence movement in Spain’s richest region.

S&P’s outlook for the Spanish economy makes for grim reading. It forecast contractions in output for this year of 1.8 percent and 1.4 percent. It said that while exports have risen, this has not offset the impact of the slump in domestic demand.

The ratings agency also joined the IMF in questioning the government’s deficit targets for this year and the next in the context of rising unemployment and a possible top-up in state pensions for this year to compensate for the loss of purchasing power due to higher-than-expected inflation. The government has also pledged to increase pensions next year.

S&P’s downgrade brings it in line with Moody's Investors Service’s rating of Baa3. Fitch Ratings has a BBB rating on Spain, one notch higher, but also with a negative outlook.

“A downgrade from S&P could be followed by a downgrade from Moody's, and while S&P did not downgrade Spain to junk, Moody's might," Reuters quoted Kathy Lien, managing director at BK Asset Management in New York, as saying.

"If Moody's goes to junk status, that's even more significant, and this adds to the pressure on Moody's to make a decision. It could lead to higher bond yields in Spain and push the government closer to asking for a bailout," Lien added.

"We view the Spanish government's hesitation to agree to a formal assistance program [...] as potentially raising the downside risks to Spain's rating," S&P said.