Spain downgraded to near 'junk' status as death spiral continues

Mounting economic and political problems in Spain have compelled Standard & Poor's to downgrade the country's credit rating to just one level above 'junk' status, contrasting with claims from the government that a ramped-up austerity programme had started to pay dividends. With its rating lowered from BB+/A-2 to BBB-/A-3, Spain is seemingly caught in what some economics have called a 'death spiral' of debt, austerity and recession. Predicting further spending constraints, rising unemployment, conflicts between central and regional governments as elections approach and deepening social discontent - S&P judged the outlook for Spain to be "negative".

The ratings agency also expressed doubts about the "eurozone governments' commitment to mutualising the costs of Spain's bank recapitalisation" and "the lack of a clear direction in eurozone policy", maintaining that these were key destabilising factors in any economic recovery - as investors could not be sure that the country's was creditworthy. As a result of the downgrade, already high borrowing costs are set to rise compounding Spain's problems. Banks in the country are struggling with a funding black hole of €60bn as a result of the property market boom and bust. And although eurozone finance ministers have agreed to loan the troubled institutions €100bn to recapitalise their accounts – the plan led the ratings agency to express concerns about the viability of the systems that had been put in place to overcome the funding gap.

"The downgrade reflects our view of mounting risks to Spain's public finances, due to rising economic and political pressures," added 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.

"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, and therefore we have lowered the rating by two notches. Spain is enduring a severe and, in our view, deepening economic recession as reflected in our real gross domestic product forecast of -1.8 per cent in 2012, and-1.4% in 2013. The pace of private sector deleveraging, together with the government's budgetary consolidation measures, is likely to lead to an even deeper contraction of investment and consumption in both the public and private sectors. In our view, the shortage of credit is an even greater problem than its cost."

Addressing the alleged lack of institutional leadership across the single currency area, S&P concluded: "The uncertain trajectory and timing of eurozone policy-making is affecting business and consumer confidence, and hence the capacity of the Spanish economy to grow." News of the downgrade comes just after the International Monetary Fund warned European governments of the perils of too much austerity. Calling for "courageous and cooperative action" from European nations to instil a sense of confidence and stability in financial markets and business sectors, IMF Managing Director Christine Lagarde said: "There are threats on the horizon, threats that can be addressed, should be addressed but are not necessarily addressed."

In a separate report published today, British think-tank Capital Economics predicted that Spain would become the fourth eurozone country to request a bail-out. Although, the report warned: "Even this will tackle only one of the symptoms of the country's problems – high borrowing costs – and not the underlying causes of chronic economic weakness and inexorably rising debt. And it will underline the fact that the eurozone crisis has reached a new level of seriousness."