Spain seems to have survived the most recent scrutiny by ratings agencies Moody’s and Standard & Poor’s. Last week, S&P hit Spain with a two-notch downgrade, but still kept them at investment grade…just barely though. Then this week, Moody’s confirmed Spain’s government bond rating at Baa3. This concluded a review for a possible downgrade that began back in June.
When moving Spain from BBB+ to BBB-, S&P focused on five factors: Spain’s delay in asking for ESM assistance, a deepening recession, Germany’s recent comments that any direct bank recapitalization by the ESM once the banking union is set up should exclude “legacy assets,” a deteriorating political climate, and likely fiscal slippage. Moody’s decision to confirm the Baa3 rating was based on three stated factors: a probable request for a precautionary credit line from the ESM (they viewed this as a positive), the government’s commitment to fiscal and structural reforms, and progress towards recapitalizing the banks.
So Spain clings its investment-grade status. But there’s still significant cause for pessimism that Spain will be able to hold on. While affirming the investment-grade rating, Moody’s has assigned a negative rating outlook – in fact, both ratings agencies would likely downgrade Spain if current expectations regarding euro-area and ECB support were to fail to materialize, or if the Spanish government botched implementation of their necessary fiscal and reform measures. However, the improvement in market conditions and Spain’s likely request for a bailout should continue to reduce tail risks in Spain and Europe generally – factors that should be sufficient to keep Spain’s credit rating by both agencies within investment grade. The longer term outlook for Spain remains negative, with a very difficult fiscal path ahead.