Following last week’s credit rating downgrade by Fitch Ratings, Standard & Poor’s announced earlier today that it too, was reducing Spain’s rating to AA-. The rating downgrade confirms that while the spotlight more often than not has been trained on Greece, other Eurozone countries continue to struggle with their own solvency issues.
While acknowledging that Spain’s outlook did improve somewhat during the year, S&P based its downgrade largely on Spain’s woefully inadequate record with respect to reducing the deficit. The government did finally commit to reducing the annual budget shortfall to 6 percent of the country’s Gross Domestic Product (GDP) by the end of 2012.
Early on, the government was able to claim some success and managed to bring the deficit down to about 9 percent of GDP after a year. Unfortunately, it appears that momentum has since stalled and there is now little chance that the deficit goal of 6 percent of GDP is possible by the original target date.
This means Spain is still forced to rely on deficit financing to meet its operational expenses; this fact underscores the precarious situation Spain now finds itself. Like Greece, Spain has been forced to increase the yields on government bonds to entice investors, and as the risk of default increases, so must yields.
Following the credit downgrade, the yield on Spanish 10-year bonds rose to 5.24 percent. While this is much lower than the incredulous 23.9 percent yield recorded earlier this week for Greece’s 10-year notes, it remains considerably higher than the benchmark German 10-year yield of 2.25 percent.
Still, if there is one silver cloud in all this bad news, it is that the yield is still below 7 percent. This is the threshold at which most analysts believe bond yields become unsustainable making some form of emergency bailout – or even a default – all but inevitable.
In addition to concerns with Spain’s lack of progress in dealing with the deficit, Standard & Poors also drew attention to what could very well by Spain’s Achilles’ Heel – the economy’s dismal employment outlook. At 21 percent, Spain has the highest unemployment rate in the entire European Union.
Spain’s unemployment troubles can be traced back to a nation-wide property bubble that blew up in spectacular fashion when the global credit crunch struck in late 2007. Prior to that, home values were rising at record rates and just as happened in so many other countries, new homeowners took on massive mortgages erroneously believing property values could only move higher.
At the same time, existing homeowners started to see their rapidly accruing equity as a savings account from which they could borrow and spend as they pleased. When property values suddenly crashed, many people found themselves holding mortgages for much higher amounts than the value of the property. Many others, due to Spanish foreclosure law which attaches debts to individuals and not the actual assets, found themselves forced to continue paying mortgages for properties they no longer owned.
The result is a population carrying the highest ratio of personal debt, living in a country with the highest unemployment rate on the continent, and administered by a government unable to spend without relying on going further into debt. Not exactly a vote of confidence for the future.
