Moody's Reduces Spain's Credit Rating

LONDON -- Moody's downgraded its credit rating on Spain Thursday, citing worries over the cost of the banking sector's restructuring and the government's ability to achieve its borrowing reduction targets.

The agency said it was reducing its rating by one notch to Aa2 and warned that a further downgrade could be in the offing if there are indications that Spain's fiscal targets will be missed and if the public debt ratio increases more rapidly than currently expected, or if the funding requirements for the so-called savings banks -- the cajas -- are greater than anticipated.

Though noting the government's resolve in dealing with its problems and that Spain's debt sustainability is not under threat, Moody's said that "Spain's substantial funding requirements -- not only those of the sovereign, but also those of the regional governments and the banks -- make the country susceptible to further episodes of funding stress."

One of the main motivations behind the downgrade was Moody's expectation that the eventual cost of recapitalizing the cajas will be much more than the government's current projections. While the government reckons the cost will be a maximum of €20 billion ($27.8 billion), or less than 2% of Spain's gross domestic product, Moody's thinks the likely cost will be near €40-50 billion and could eventually come in at a massive €100-120 billion.

The Spanish government is trying to get a handle on its borrowings by reducing spending and raising taxes. The expectation in the markets is that the country managed to reduce its budget deficit from over 11% of national income in 2009 to around 9% last year.

However, it's doing all this at a time when unemployment remains elevated above 20%, following the collapse of a property and construction boom that sent the economy skidding into a two-year recession.

The big worry in the markets is that Spain will get sucked into Europe's debt crisis, which has already seen Greece and Ireland get financial bailouts from their partners in the EU and the International Monetary Fund. Portugal is widely expected to be next.

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