Spain on Credit Watch

The international rating agency Standard & Poor’s announced last Monday January 12 that it had issued a downgrade warning on Spain’s triple-A sovereign rating. The news came as a surprise for the Spanish political elite, but was no surprise for investors in view of the increasing yield spread between the Spanish ten-year bonds and their German counterparties, at their highest level since the launch of the Euro in January of 1999.

In the meantime Pedro Solbes, Spain’s finance minister, acknowledged that this year’s deficit will be significantly higher than the 3% mark established by the European Union as one in four convergence criteria according to the Maastricht Treaty. France and Germany have surpassed the 3% mark in previous years without receiving any sanctions. This free-riding behavior that was not punished may have its consequences for countries like Spain or Italy. Spain would not understand a penalty if it surpasses a 3% deficit, because France and Germany have not received it in the past. It would be discriminatory for Spain. Perhaps France and Germany are too big to be punished. What about Spain?

In 2007 Spain ran a surplus of 2.27% of GDP. As of November end Spain had accumulated a deficit of 1.28% without incorporating regional or local debt. Regarding the rating Solbes reported to EL MUNDO that there are other rating agencies that may not downgrade Spain’s financial strength. Spain is likely to be downgraded because the economy will not recover, according to many, until 2011 in the best case scenario. There is not a clear economic policy making process that is implementing reform in key areas. The current Socialist Administration seems to be short on ideas. Solbes is only a shadow of what he once was in the four first years of Presidency of Jose Luis Rodriguez Zapatero.

So what lies ahead? For the time being not much. It is likely that Moody’s and Fitch Ratings also issue warnings. Zapatero continues to maintain his Labour Minister Corbacho, who lacks an economic background and seems incapable of doing much before the monster he has been ordered to fight: a staggering unemployment rate that is not only the highest in any OECD country, but also is continuing to increase with no clear ceiling. Everyone is tightening the belt. We will continue to suffer and reform is well needed.

To Spain’s benefit is one of the lowest debt-to-GDP ratios of any triple-A economy. Italy’s staggering 104% debt-to-GDP ratio has dragged the country for years and is likely to continue to do so in the current economic turmoil. Spain can afford to run deficits for three more consecutive years. That is not the issue. The issue is what comes next. The issue is what comes in 2012 when Zapatero is supposed to run for a third term. In the current environment anticipated elections are not likely to be triggered. Who know what to do? It seems that even Cristobal Montoro and his team on the conservative side are also short on ideas.

The problem of Spain is a problem of engine of growth and perhaps lack of diversification. The country relied too much and too long on the construction sector as an engine of growth, without investing the proceeds in finding an alternative sector that could replace that of construction and real estate. We must acknowledge it. We killed the chicken of the golden eggs and now wonder what to do.