S&P cuts Spain’s rating to BBB- with negative outlook

Rating agency Standard & Poor’s has lowered its long-term sovereign credit rating on Spain to BBB- from BBB+, with a negative outlook on the long-term rating of the country.

“The downgrade reflects our view of mounting risks to Spain’s public finances, due to rising economic and political pressures,” the agency said.

According to S&P, the central government’s policy responses are likely to be constrained by a severe and deepening economic recession that could lead to increasing social discontent and rising tensions between Spain’s central and regional governments and a policy setting framework among the eurozone governments that in our opinion still lacks predictability.

“Our understanding from recent statements is that the Eurogroup’s commitment to break the vicious circle between banks and sovereigns, as announced at a summit on June 29, does not extend to enabling the European Stability Mechanism to recapitalize large ongoing European banks,” it added.

Moreover, 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.

With local elections approaching and many regional governments facing significant financial difficulties, tensions between the central and regional governments are also rising.

“These rising domestic constraints are, in our view, likely to limit the central government’s policy options,” the company said.

Looking ahead, the 2013 state budget is based on overly optimistic growth assumptions (government real GDP forecast of -0.5%).

Fiscal targets are likely to be undermined by a continuous decline in employment, as well as the government’s proposal to possibly index pensions before year-end 2012, and to raise them in 2013, S&P said.

“We view the Spanish government’s hesitation to agree to a formal assistance program that would likely significantly lower the sovereign’s commercial financing costs via purchases by the European Stability Mechanism and ECB as potentially raising the downside risks to Spain’s rating”.

Overall, against the backdrop of a deepening economic recession, analysts at the agency believe that the government’s resolve will be repeatedly tested by domestic constituencies that are being adversely affected by its policies.

“Accordingly, we think the government’s room to maneuver to contain the crisis has diminished,” it said.

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