Spanish Debt Rating Downgraded

As Spain remains mired in recession, confidence in the government’s ability to improve public finances is deteriorating.

Spain’s debt was downgraded a notch by Moody’s Investors Service on Thursday, triggering sharp declines for the euro and European bond prices on the market.

Moody’s raised concerns over the Spanish government’s ability to improve its finances in the face of disappointing growth rates and public anger at spending cuts. The ratings warned that further downgrades were possible as the costs of bank restructuring could “considerably exceed” current projections.

Spain, which has the highest rate of unemployment in the eurozone at about 20 percent, is under pressure from investors and fellow European Union member states to reduce its budget deficit which is also among the highest in the region.

The Spanish economy expanded by 0.2 percent in the fourth quarter of last year but contracted mildly over the whole of 2010.

The country’s socialist prime minister José Luis Rodríguez Zapatero has been trying to convince markets of Spain’s solvency but as the willingness of private banks to lend and invest remains low, it is difficult to imagine Spain recovering soon. Zapatero has announced labor law and pension reforms but with trade unions marching against austerity and his own approval rating down to approximately 25 percent, he may not have the political capital anymore to push for necessary spending cuts.

The government approved a budget last year that is designed to cut the deficit in half, down to 6 percent of GDP. Measures in the budget included cutting public spending by 7.7 percent, including a 5 percent pay cut for public-sector workers, and increasing personal income taxes for those earning more than €120,000 euros a year.

Spain will see its fiscal strength tested later this year when it is due to repay lenders €192 billion, about a fifth of its total debt.

As a result of increased interest it would have to pay for new borrowing, the Spanish government expects to see a rise of 18 percent in the cost of financing its debt.

Unless Spain manages to rein in public spending soon and restore investors’ confidence, interest payments on its debt will only continue to grow as a result of its budget woes up to a point where the country can no longer afford to borrow.

Earlier this week, Moody’s also downgraded Greece’s credit rating, fueling anxiety in Europe that the single currency zone is not out of debt crisis yet.

European Union leaders were due to convene on Friday to discuss a future permanent bailout mechanism for the eurozone to replace the temporary fund that was cobbled together last year after Greece’s debt crisis threatened the stability of the monetary union.

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