S&P Cuts Spain's Debt Rating on Policy Worries

Spain on Monday became the second euro zone country in less than a week to have its credit rating cut by Standard & Poor's, stoking fears of more downgrades across the recession-hit currency bloc as its members' public finances decay.

Just as it did last week when it cut Greece's sovereign rating, S&P said Spanish government policy might be insufficient to counter what is expected to be the country's worst recession in half a century and could cause a severe deterioration in public finances.

The cut in Spain's rating to "AA+" from "AAA," a level Spain had held since late 2004, sent the euro to a session low against the dollar as investors feared Portugal and Ireland would suffer the same fate after receiving S&P warnings last week.

"This isn't much of a surprise. It was obvious after Greece's downgrade," said Jose Garcia Zarate at the 4Cast consultancy. "I'd expect further fuel to the argument of a break-up of the euro zone."

The spread on Spain's 10-year bond against the benchmark German bund remained steady at 114 basis points after it hit a fresh record of 122 earlier on Monday.

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"The downgrade of the sovereign reflects our expectations that public finances will suffer in tandem with the expected decline in Spain's growth prospects, and that the policy response may be insufficient to effectively counter the related economic and fiscal challenges," S&P credit analyst Trevor Cullinan said in a statement.

A senior Spanish official said S&P's cut was unjust after government fiscal controls allowed Spain to run three years of budget surpluses to 2008 after three decades of deficit.

"It seems unfair to me, given this government's fiscal record," said the source, who asked not to be named.

An Economy Ministry spokeswoman said Spain's solvency was beyond question.

BNP Paribas economist Dominic Bryant said S&P was looking further ahead at the fiscal cost of over 70 billion euros in economic stimulus plans which Spain will pay for with public borrowing.

"They must be thinking that they're going to be running deficit for a long period to get the debt level up sufficiently high to warrant cutting the ratings," said Bryant.

Spain expects its budget deficit to swell to almost 6 percent of GDP this year, and not return close to an European Union limit of 3 percent before 2012.

It has increased public borrowing over 50 percent this year to pay for the plans and sees its debt rising to 54 percent of gross domestic product by 2011, from about 40 percent last year.

Such deficit and debt levels are comparatively low compared with some European countries, but could become difficult to contain as growth dwindles and euro zone economies compete for scarce financing.

Fears fiscal balances are becoming unsustainable have fed talk of on a possible breakup of the 16-member currency bloc.

"I don't believe we'll see anything like this, but the market is speculating that this could happen and is pricing in a probability of this maybe happening," said Niels From, chief analyst at Nordea in Copenhagen.

EU Economic and Monetary Affairs Commissioner Joaquin Almunia played down the risk of one of the euro zone's 16 nations defaulting on its debt as the euro fell.

"I don't think at all the risk of default is important. Risk of default ... always exists in the private and public sectors, but in the case of euro area members I don't think the risks are high or are significant," Almunia told a news conference.

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