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Sunday, May 30, 2010

Bonfire of the sovereign ratings: Fitch strips Spain of its triple-A rating

From FT Alphaville:

"Fitch Ratings-London-28 May 2010: Fitch Ratings has today downgraded Spain’s Long-term foreign and local currency Issuer Default Ratings (IDRs) to ‘AA+’ from ‘AAA’. The rating Outlooks on both Long-term IDRs are Stable. Fitch has simultaneously affirmed Spain’s Short-term rating of ‘F1+’ and the Country Ceiling of ‘AAA’.

“The downgrade reflects Fitch’s assessment that the process of adjustment to a lower level of private sector and external indebtedness will materially reduce the rate of growth of the Spanish economy over the medium-term,” says Brian Coulton, Fitch’s Head of EMEA Sovereign Ratings.

“Despite government debt and associated interest costs remaining within the AAA range, Fitch anticipates that the economic adjustment process will be more difficult and prolonged than for other economies with AAA rated sovereign governments, which is why the agency has downgraded Spain’s rating to AA+,” Coulton added.

Although the rebalancing of Spain’s economy is firmly underway, the inflexibility of the labour market and the restructuring of regional and local savings banks (cajas) will, in Fitch’s opinion, hinder the pace of adjustment, particularly in the aftermath of the real estate boom. Consequently, and despite a strong commitment to reducing the budget deficit – as demonstrated by additional recent measures announced by the government such as the 5% reduction in civil service pay – government debt will likely reach 78% of GDP by 2013 compared to under 40% prior to the onset of the global financial crisis in 2007 and the subsequent recession. Nonetheless, Spain’s sovereign credit profile remains very strong and is underpinned by a high-income and diversified economy, a ‘core’ financial sector that is sound, a relatively high national savings rate and a track record of responsible public finances including an unblemished modern debt-servicing record.

The fiscal consolidation programme set out by the government is ambitious and supported by specific and detailed measures, some of which have already been implemented. However, Fitch believes that the economic recovery will be more muted than that forecast by the government. Servicing the significant external interest burden implied by Spain’s large negative net international investment liability position will reduce disposable income and require a shift of resources to the traded sector of an economy whose exports are a relatively small contributor to GDP.

In addition, the final costs of restructuring the ‘caja’ sector could be substantial, although even in a highly ’stressed scenario’ they would be significantly less than the potential EUR99bn set aside under the Fund for Restructuring of Banks (FROB). In addition, under Fitch’s base-case scenario, these costs would be less than that incurred by several other governments, reflecting the strong financial profile of Spain’s largest financial institutions.

Despite these expectations, the Stable Outlook on Spain’s sovereign rating reflects Fitch’s view that the country’s credit profile will remain very strong and consistent with its ‘AA+’ rating, even in the event of some slippage relative to official fiscal targets.

The continuing volatility in European financial and sovereign bond markets is expected to persist until a global and European economic recovery and fiscal consolidation is firmly secured. Nevertheless, the recently announced EUR500bn European stabilisation mechanism, buttressed by potentially EUR250bn of lending from the IMF and the ECB’s ‘Securities Markets Programme’ significantly reduces the risk of severe funding distress for Euro Area sovereigns. In addition, ECB liquidity facilities will continue to underpin the funding of European financial institutions."