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Published by: andrew_trotman1455 on Apr 26, 2012
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05/16/2012

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OverviewWebelievethattheKingdomofSpain'sbudgettrajectorywilllikelydeteriorateagainstabackgroundofeconomiccontractionincontrastwithourpreviousprojections.Atthesametime,weseeanincreasinglikelihoodthatSpain'sgovernmentwillneedtoprovidefurtherfiscalsupporttothebankingsector.Asaconsequence,webelievethereareheightenedrisksthatSpain'snetgeneralgovernmentdebtcouldrisefurther.Wearethereforeloweringourlong-andshort-termsovereigncreditratingsonSpainto'BBB+/A-2'from'A/A-1'.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impactwebelievethiswilllikelyhaveonthesovereign'screditworthiness.RatingActionOnApril26,2012,Standard&Poor'sRatingsServiceslowereditslong-termsovereigncreditratingontheKingdomofSpainto'BBB+'from'A'.Atthesametime,weloweredtheshort-termsovereigncreditratingto'A-2'from'A-1'.Theoutlookonthelong-termratingisnegative.Ourtransferandconvertibility(T&C)assessmentforSpain,asforallEuropeanEconomicandMonetaryUnion(EMUoreurozone)members,is'AAA',reflectingStandard&Poor'sviewthatthelikelihoodoftheEuropeanCentralBank(ECB)restrictingnon-sovereignaccesstoforeigncurrencyneededfordebtserviceofnon-euroobligationsislow.Thisreflectsthefullandopenaccesstoforeigncurrencythatholdersofeurocurrentlyenjoyandwhichweexpecttoremainthecaseintheforeseeablefuture.RationaleThedowngradereflectsourviewofmountingriskstoSpain'snetgeneralgovernmentdebtasashareofGDPinlightofthecontractingeconomy,inparticulardueto:â
¢Thedeteriorationinthebudgetdeficittrajectoryfor2011-2015,incontrastwithourpreviousprojections,andâ
¢Theincreasinglikelihoodthatthegovernmentwillneedtoprovidefurtherfiscalsupporttothebankingsector.Consequently,wethinkrisksarerisingtofiscalperformanceandflexibility,andtothesovereigndebtburden,particularlyinlightoftheincreasedcontingentliabilitiesthatcouldmaterializeonthegovernment'sbalancesheet.Theseconcernshaveledustoconcludeatwonotchdowngradeiswarrantedinaccordancewithourmethodology.Underourrevisedbase-casemacroeconomicscenario,whichweviewasconsistentwiththedowngradeandthenegativeoutlook,wehaveloweredourforecastforGDPtocontractinrealtermsby1.5pcin2012and0.5pcfor2013.WehadpreviouslyforecastrealGDPgrowthof0.3pcin2012and1pcin2013.WebelievethatnegativedragsonGDPinclude:â
¢Decliningdisposableincomes;â
¢Private-sectordeleveraging;â
¢Implementationofthegovernment'sfront-loadedfiscalconsolidationplan;andâ
¢TheuncertainoutlookforexternaldemandinmanyofSpain'skeytradingpartners.Inouropinion,theSpanisheconomyisrebalancing,andthemeasuresthegovernmenthastakenshouldfacilitatethisprocess.Spain'scurrentaccountdeficit(CAD)isonanarrowingtrajectory,significantlysupportedbytheSpanisheconomy'sstrongexportperformance,especiallysince2009.TheCADwas3.5pcofGDPatyear-end2011,comparedwith10pcin2007.Excludingtheincomedeficit,thecurrentaccountisinbalance.Theincomedeficit,whichreflectsnetinterestanddividendpaymentsonSpain'snetliabilitiestotherestoftheworld,widenedin2011onthebackofincreasedexternalfundingcosts.Weexpectthecurrentaccounttobroadlybalancein2013-2014,beforepostingahighersurplusthereafter.Incontrastto2008-2010,theBankofSpain-throughTarget2overdraftswiththeECB(exceedingâ
¬250bninMarch2012,fromaroundâ
¬150bnattheendof2011)-hasnowbecomethemajorsourceo
 
ffinancingSpain'sCAD.Inouropinion,thisreflectstheextenttowhichSpain'scommercialbankingsystemhassharplyincreaseditsdependencyonofficialfundingsourcestoaconsiderablyhigherlevelthanweanticipatedinJanuary,whenwelastrevisedourratingonSpain.Despitetheunfavorableeconomicconditions,webelievethatthenewgovernmenthasbeenfront-loadingandimplementingacomprehensivesetofstructuralreforms,whichshouldsupporteconomicgrowthoverthelongerterm.Inparticular,authoritieshaveimplementedacomprehensivereformoftheSpanishlabormarket,whichwebelievecouldsignificantlyreducemanyoftheexistingstructuralrigiditiesandimprovetheflexibilityinwagesetting.Evenif,inouropinion,thereformisunlikelytoeliminatethestructuraldualityintheSpanishlabormarket,webelieveitwillultimatelybenefitemploymentgrowthonceasustainablerecoverysetsin.Inthenearterm,increasedlabormarketflexibilityislikelytoacceleratethenecessarywageadjustmentandreducethepaceofjob-shedding.Atthesametime,wedonotbelievethelaborreformmeasureswillcreatenetemploymentinthenearterm.Asaconsequence,thealreadyhighunemploymentrate-especiallyamongtheyoung-willlikelyworsenuntilasustainablerecoverysetsin.Financialsectorreform,announcedinFebruary2012,requiresbankstoallocateadditionalloanlossprovisionsandraisecapitalbuffersonexposuretorealestatedevelopmentsandconstructionprojects.Webelievethesesectorswillcontinuetobethemainsourcesofassetqualitydeterioration.Thereformhasalsoledtofurtherbankingsectorconsolidation.Recentacquirershavebenefitedfromassetprotectionschemes,withpotentiallossescoveredbyapartial(80pc)guaranteeprovidedbytheDepositInsuranceFundtoabsorbfuturecreditlossesfromtheacquiredbanks'legacyportfolios.Weestimatethattheguaranteesrelatedtotheseschemes,combinedwiththosethatwilllikelybeprovidedintheupcomingsaleofthreeentitiescurrentlycontrolledbytheFondodeReestructuracionOrdenadaBancaria(FROB),representacontingentliabilityforthesovereignintheamountofabout3.75pcofGDP.Combinedwithembeddedrisksintherestofthebankingsector,publicenterprises,andotherstateguarantees,wenowestimatecontingentfiscalriskstothesovereignasmoderate,asdefinedinourcriteria.WebelievetheECB'srecentlong-termrepurchaseoperations(LTROs)havesignificantlyreducedtheriskstheSpanishbankingsectorfacedinrefinancingitsmedium-termexternaldebtanditsshort-terminterbankliabilitiesmaturinginthefirsthalfof2012.TheLTROalsohelpedbankstofinancetheirgovernmentdebtportfolioscheaply.Nevertheless,wedonotviewtheprovisionofliquiditysupportbythemonetaryauthoritiesasasubstituteforfinancialsectorrestructuringandeconomicrebalancing.Inourview,thestrategytomanagetheEuropeansovereigndebtcrisiscontinuestolackeffectiveness.Wethinkcreditconditions,andhencetheeconomicoutlookforSpain,couldnowdeterioratefurtherthanweanticipatedearlierthisyearunlessoffsettingeurozonepolicymeasuresareimplementedtosupportinvestorconfidenceandstabilizecapitalflowswiththerestoftheworld.Suchmeasuresattheeurozonelevelcouldincludeagreaterpoolingoffiscalresourcesandobligations,possiblydirectbanksupportmechanismstoweakenthesovereign-banklinks,andaconsolidationofbankingsupervisionoragreaterharmonizationoflaborandwagepolicies.Inlightoftherapidriseinpublicdebtsince2008,weexpecttheSpanishgovernmenttoimplementasustainedbudgetaryconsolidationeffort-includingstrengtheningfiscalsurveillanceframeworksattheregionalgovernmentlevel-aimedatgraduallyreducingthegovernment'snetfinancingneeds.Balancingthiscommitmenttostabilizingpublicfinanceswithpolicymakers'clearinterestinpreventinganaccelerationoftheeconomicdownturnwillbechallengingintheabsenceoffiscaltransfersfromabroad,orprivate-sectorcreditcreationathome.Atthesametime,webelievefront-loadedfiscalausterityinSpainwilllikelyexacerbatethenumerousriskstogrowthoverthemediumterm,highlightingtheimportanceofoffsettingstimulusthroughlabormarketandstructuralreforms.

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