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Mardi 18 Juin 2013

Ratings On Spain Affirmed At 'BBB-/A-3'; Outlook Negative

In our view, Spain's commitment to the implementation of a comprehensive fiscal and structural reform agenda remains strong. We are therefore affirming our long- and short-term sovereign credit ratings on Spain at 'BBB-/A-3'. The outlook on the long-term rating remains negative, reflecting the potential for a downgrade if political support for the current reform agenda wanes, the budgetary position significantly deteriorates, or if eurozone policies falter in stabilizing Spain's funding costs.

Standard & Poor's Ratings Services today affirmed its long- and short-term sovereign credit ratings on the Kingdom of Spain at 'BBB-/A-3'. The outlook on the long-term rating remains negative.

Our 'BBB-' long-term sovereign credit rating on Spain is supported by our view of its diversified and prosperous economy, and the government's ongoing implementation of a comprehensive financial, fiscal, and structural reform agenda. The rating is constrained by our view of the high external leverage in Spain's economy, as well as its relatively low medium-term economic growth prospects and residual inflexibilities such as its still-highly-segmented labor market.

The Spanish economy is undergoing prolonged structural adjustment. We estimate its real GDP will contract by about 1.5% in 2013 before slowly recovering. We forecast about 0.6% real GDP growth in 2014 on the back of still-weak consumption--constrained by declining disposable income due to high unemployment, reduced wages, and budgetary consolidation--but with improved export performance contributing to the slightly positive growth trend. We expect investment activity to remain subdued as the private sector deleverages its balance sheets and bank claims decline. Given that Spanish corporate borrowers face higher interest rates than elsewhere in the European Economic and Monetary Union (eurozone), partly due to what we view as a challenged monetary transmission mechanism, we believe investment levels will pick-up only slowly over the medium term.

Positively, we believe that the Spanish economy is recalibrating. The focus appears to be moving toward external demand--as strong goods and services exports have shown since 2010. The current account deficit declined to 1% of GDP in 2012, from almost 10% in 2008, and we expect a surplus in 2013. In the medium term, we believe the current account will strengthen gradually as a result of the ongoing reorientation toward external demand, and while sluggish domestic demand continues.

Spain's competitiveness is also steadily improving: an adjustment that has benefited from the 2012 labor market reforms. Eurostat estimates that Spanish unit labor costs have decreased by around 10% since peaking in mid-2009; importantly, this adjustment is no longer occurring primarily via rising unemployment.

While we view the shift in external flow dynamics positively, we note that Spain’s external vulnerabilities persist given its large stock of external debt, as well as its large net international liability position at just under 100% of GDP. Still-high external borrowing costs for the private sector are compounding Spain's external vulnerabilities and delaying its economic recovery, but funding conditions appear unlikely to improve in the near term without specifically-targeted additional monetary policy measures. A high level of credit risk--due to the economic crisis and financial-sector restructuring--is also a key impediment to credit activity resuming. While larger companies can access capital markets via bond issuance, Spain's many small and midsize enterprises still depend on bank financing.

Despite the robust export performance, we expect unemployment to remain very high, at above 26%, at least until there is a sustained economic recovery. Moreover, we believe that increased structural unemployment and unfavorable investment trends--compounded by demographic changes, including an aging population--are undermining the economy’s medium-term growth potential.

The European Commission has recommended to the Spanish government that it decelerate its nominal budgetary consolidation trajectory so that it reaches a budget deficit of 6.5% of GDP in 2013, 5.8% in 2014, 4.2% in 2015, and 2.8% in 2016. We believe that the government will likely meet these eased targets in 2013 and 2014, but that additional revenue or expenditure measures may be needed. The 2013 budget relies partly on several measures that the government adopted in the second half of 2012 and about 0.3% of GDP of additional planned budgetary measures. The government has said that it will address any deviation from budgetary targets by taking additional and timely actions. In our opinion, these could include reductions in existing tax exemptions; changes to indirect taxation; the only-partial restoration of end-year public-sector salary payments; or changes in the social security system. We expect that ongoing pension reform discussions could alleviate social-security-related budgetary pressures, although pension adequacy will need to be taken into account to avoid additional stress to the social fabric, such as increased poverty risks.

The government plans to accelerate its nominal budgetary consolidation measures in 2015 and 2016. Apart from the expected slow economic recovery, we believe the lead-up to the 2015 general elections may result in medium-term implementation risks.

We forecast net general government debt at 82% of GDP in 2013--rising to about 91% in 2015--as a result of continuous large budget deficits and low nominal economic growth. We estimate the ratio of general government interest expenditure to general government revenues at about 9.2% on average during 2013-2015 (see our selected indicators for Spain).

The negative outlook reflects our opinion that we could lower the ratings on Spain during the next 12-16 months if, all else being equal, we observe that:
- Political support for the current reform agenda is waning. For example, the government's willingness to implement additional reforms could weaken if GDP growth were to contract more steeply than currently anticipated, or if unemployment worsened;
- Eurozone support is failing to engender sufficient investor confidence to keep government borrowing costs at sustainable levels and to stem potential capital outflows; and
- Net general government debt looks likely to exceed 100% of GDP due to deviations from the government's fiscal targets, weakening growth, one-off debt-increasing items (for example from additional contingent liabilities), or if interest payments rise above 10% of general government revenues.

We could revise the outlook on the rating to stable if we see continuous improvements in the economy’s external position, even as growth resumes, or if the government's budgetary and structural reform measures, coupled with ongoing eurozone support, stabilize Spain's credit metrics.

Standard & Poor's Ratings Services, part of McGraw Hill Financial (NYSE: MHFI), is the world's leading provider of independent credit risk research and benchmarks. We publish more than a million credit ratings on debt issued by sovereign, municipal, corporate and financial sector entities. With over 1,400 credit analysts in 23 countries, and more than 150 years' experience of assessing credit risk, we offer a unique combination of global coverage and local insight. Our research and opinions about relative credit risk provide market participants with information and independent benchmarks that help to support the growth of transparent, liquid debt markets worldwide.

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