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Moody's Investors Service, the only rating agency that have kept the maximum credit grade for Spain, said it may downgrade the country's sovereign rating by one or two notches, citing weakened growth outlook.
Moody's, currently keeping an Aaa rating for Spain, said that the government faced challenges to achieve its fiscal targets, and that there were concerns for the impact of short-term financial costs.
The Spanish stock market opened the month of July lower, although the outcome of the Treasury's five-year bond auction limited the losses.
LASTING DETERIORATION
Moody's recently placed Spain's Aaa rating on a three-month review for a possible downgrade, citing the "lasting deterioration" of the Spanish economy and its "weak" growth outlook in comparison with other eurozone countries.
The agency also confirmed rating cuts for several Spanish autonomous regions, all by one notch. Outlook was negative for all the regions.
Two weeks ago, the regional governments unanimously agreed to slash their spending by 11 billion euros in 2010 and 2011, hoping to reduce their share in the national deficit, which should not exceed 1.3 percent next year.
Standard & Poor's welcomed the agreement between the central and regional governments to cut spending, although it warned that the adjustment measures may be "insufficient" if revenues are lower than expected.
Moody's is the only major rating agency to retain the maximum grade for Spain's sovereign debt. On April 28, Standard & Poor's reduced Spain's rating to Aa with bad forecasts. Fitch did likewise on May 28, settling for an Aa+ with a stable outlook.
Kathrin Muehlbronner, Moody's vice president and chief analyst for Spain, said Spain's growth outlook are "weaker" than other countries with the same rating, with a modest GDP growth forecast until 2014.
It will take several years for the Spanish economy to absorb the collapse of the real estate sector, reduce the levels of private debt and find new sources of economic growth, Muehlbronner said.
Moody's estimates that GDP growth for the next four years will be in the region of one percent. Such weak growth figures further complicates the "very challenging" process of financial consolidation, it said.
Moody's will consider different factors when it comes to Spain's rating review, including the government's compromise with the banking sector restructuring, the efficiency of the reforms to generate long-term growth, the regional government's contribution, and particularly the national budget for 2011, which will be announced in September.
GOVERNMENT RESPONSE
The government quickly responded, with Prime Minister Zapatero reiterating his "full confidence in his country's strength and solvency, adding that the recent reforms will be useful since the economy will sustain its growing strength.
"We will reduce unemployment and we will deliver all the principles which may generate greater confidence in markets and in public opinion in the international economic arena" he said.
Following Moody's announcement, the Treasury allocated 3.5 billion euros in five-year bonds, fulfilling the Treasury's maximum target for the sale. Costs, however, increased once again, reaching a yield of 3.72 percent, slightly above the 3.58 percent registered on the previous sale.
Nevertheless, the auction's 3.7 percent interest is nearing four percent.In case the interest rates continue to rise, Spain would benefit by receiving aid from the EU's fund rather than by selling more of its debt in private markets.
The success in recent auctions is an indication of market confidence that the Treasury will be able to meet the large debt redemptions in July, as obligations to be fulfilled amounts to 24.66 billion euros.