Spain: You know times are tough when markets greet Spain's credit downgrade with relief. Moody's is the last of the rating agencies to knock Spain's AAA rating, but it did so by just one notch and with a stable outlook. The downgrade was expected. It could have been more severe. This should encourage the government to stick to its guns on fiscal discipline, as it sends its austerity budget to Parliament. If growth stalls, as looks likely, it will have to do more.
Moody's move is something of a lagging indicator, to put it mildly. The main reasons for the downgrade, as the other agencies have also pointed out, is Spain's weak growth prospects. The Socialist government aims to cut the budget shortfall to 6 percent of gross domestic product in 2011 from 11.1 percent last year, bringing it within the EU's 3 percent limit in 2013.
But these plans rely on optimistic growth forecasts, which boost revenue projections. Moody's estimates that growth will average 1 percent in the next few years, against the government's own forecast of 1.3 percent next year and 2.5 percent in 2012. While the government might meet its budget deficit targets this year and in 2011, Moody's says it will have to do more to achieve its targets thereafter.
On that basis alone, the rating agency could have downgraded more, or at least kept the outlook negative. But it is giving Spain the benefit of the doubt, and seems to trust the government's commitment to cut the deficit. Yet Madrid should not be lulled into a false sense of security. The country's debt spreads may be far lower than those of troubled Portugal and Ireland.
But markets are fickle and Spain is still highly dependent on them. It still faces debt financing needs of 192 billion euros next year, of which 43.3 billion is new debt. This should keep up the pressure on the government to stick to its plans of reforming labour markets and the pension system. One big false move, and the mood could turn sour again.