In a report last Thursday, credit ratings agency Moody’s downgraded the ratings of Spain’s government debt from Aa1 to Aa2. What’s more, they kept a negative rating outlook! I don’t see Charlie Sheen anywhere, so what’s up with all the hatin’?
Why was Spain downgraded?
According to the data, Moody’s expects Spain’s banks to need around 40-50 billion EUR worth of new debt to restructure its capital. These numbers contrast sharply against the Spanish central bank’s report which shows a need for only 15.50 billion EUR worth of debts. In fact, Moody’s even estimates that Spain’s recapitalization costs could go up to 110-120 billion EUR in a worst case scenario. Ack! You could buy ALL of Apple’s 600,000 iPad2s out this weekend with that much money!
In addition to those staggering figures, my forex minions found out that Moody’s is also worried about Spain’s economic growth. Apparently, the country is still heavily dependent on imported energy. Uh-oh, with prices raising the chart roofs lately, I bet that’s bad news for the country’s GDP. And because of Spain’s exposure to energy prices, the agency doesn’t expect the Spanish economy to grow faster than 1.5% per year over the next four years. Heck, that’s still slower than the height growth rate of Happy Pip, our resident Comdoll trader! I’m kidding, Happy. Stay awesome.
Another concern that has been haunting markets is the Spanish government’s lack of control over its regional government spending. Did you know that a total of 17 regional banks have already spent more money than their deficit targets just for the past year? I don’t know about you, but with expected GDP growth only at 1.5% a year max, I say that’s bad for Spain’s debt-to-GDP ratio!
So how did markets react to the downgrade?
The euro bulls got spooked, of course! EUR/USD plunged to a low of 1.3775 on that day! You see, a credit rating downgrade basically means that the government would have to pay more in order to borrow the same amount of money. By having to pay more, the economy is at bigger risk of slower growth and might trigger a vicious cycle of downgrades and slower growth. In fact, the difference between the cost of borrowing for Spain to that of Germany‘s benchmark rate had already jumped to 2.27% on Thursday when it was only at 2.20% on Wednesday.
What got investors worrying though is that Spain is the Euro Zone‘s largest economy in financial trouble. If the Spanish economy slips some more and finally asks for a bailout, other EZ economies might not be willing to shell out enough money to pull it out of its debt mess. This could cause not only Twitter and Facebook wars among the EZ leaders’ character accounts, but also cause the loss of investor confidence on the euro.
Should we expect Spain to file for a bailout soon?
Well, not necessarily. The silver lining in Moody’s report is that it doesn’t expect Spain to need support from the European Financial Stability Fund since its debt levels are still relatively sustainable.
Also, markets are holding on to the central government’s determination to keep Spain‘s debt levels low. Since its regional governments badly need slaps on the wrists for their overspending, it’s good to know that someone is at least making efforts to whip them into shape.
Speaking of making efforts, let’s not forget the heads of the Euro Zone economies themselves! Even though word around the forex grapevine is that their latest meetings are doing more harm than good to the euro, we can’t overlook the fact that they have the power to implement laws that could finally put an end to the whole region’s debt problems.. Best keep our fingers crossed then!