Credit Trouble for Spain and Greece Spreads Fears of Sovereign Defaults

Standard & Poor's today (Wednesday) cut its credit outlook for Spain to "negative" from "stable," fanning concerns that sovereign defaults will spread throughout the global economy.

The dimmer outlook for Spain "reflects the risk of a downgrade within the next two years," S&P said.

It also increased fears among investors that the world could see a wave of global credit defaults. After the default of state-owned Dubai World forced investors to think twice about the recent rally in global stocks, Fitch Ratings Inc. on Tuesday cut Greece's credit rating to BBB+ from A-minus.

"The downgrade reflects concerns over the medium-term outlook for public finances given the weak credibility of fiscal institutions and the policy framework in Greece, exacerbated by uncertainty over the prospects for a balanced and sustained economic recovery," said Fitch.

Greece has failed to contain its deficit, which this year is expected to total 12.7% of gross domestic product (GDP). The country's current account deficit rose to nearly 15% of GDP last year, but probably fell below 9% for 2009.

Meanwhile, the European Commission (EC) projects Greece's total government debt will exceed 112% of GDP. In downgrading the nation's credit, Fitch said government debt was likely to rise to close to 130% of GDP before stabilizing, and that proposed pension reforms, spending cuts and broadening of the tax base would likely not be strong enough to reduce its debt burden.

However, Greece is just one of the region's troubled economies. Europe's most vulnerable countries have been nicknamed the "PIGS," - Portugal, Ireland, Italy, Greece, and Spain.

Fitch has downgraded its outlook on Portugal's sovereign-credit rating to "negative" from "stable," as well, citing a deterioration of public finances.

However, Spain could be most at risk, Credit Suisse Group AG (NYSE: CS) analysts said in note to clients.

"To us domestic Spain looks most vulnerable," said Credit Suisse. "Productivity growth has been zero for 20 years, so Spain can't innovate its way out of the crisis."

The bank cited figures from the International Monetary Fund (IMF) that indicate Spain's housing sector it still 12% overvalued, and that with a house price to wage ratio of 6.2, is probably even more overvalued. At its peak, 20% of GDP was accounted for by the housing sector and construction.

"Spain is about 20% overleveraged, looking at private sector debt as a proportion of GDP versus GDP per capita. And its aggregate leverage (private and government) is higher than that of Greece," Credit Suisse said. "In our opinion, reducing Spain's sizable fiscal and economic imbalances requires strong policy actions which have not yet materialised."

Spain's budget deficit will be one of the widest in the euro-region this year at 11.2% of GDP, according to the EC.

S&P put Greece's debt on watch for a downgrade two days ago, following Fitch's downgrade. The ratings agency in March cut Ireland's triple-A sovereign debt rating by one notch and downgraded Portugal's rating in January.  

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