* Moody's flags Spain's vulnerability to funding stress
* Says has serious concerns about regional funding
* Spanish Treasury says downgrade reflects short-term mkts
By Walter Brandimarte and Elisabeth O'Leary
NEW YORK/MADRID, Oct 19 Moody's cut Spain's
sovereign rating by two notches, citing the country's
vulnerability to the euro zone debt crisis and piling pressure
on EU leaders to act decisively at a summit this weekend.
It was the third, and most aggressive downgrade of Spain by
a major rating agency in recent weeks. Moody's warned it could
downgrade the euro zone's fourth-largest economy again if the
crisis escalates further, saying high levels of debt in the
banking and corporate sectors leave Spain vulnerable to funding
Standard & Poor's and Fitch Ratings both rate
Spain one notch higher than Moody's, which cut Spain's rating to
A1 from Aa2.
Madrid has said it will get its public deficit
down to 6 percent of GDP this year from 9.3 percent of GDP in
2010, but many economists say that is ambitious given a lack of
fiscal discipline at regional government level.
"Downgrades of Spain's credit rating are coming fast and
furious and are a reminder that the agencies, and many investors
for that matter, have not become more sanguine about Spain. They
have just become more concerned about Italy," said Nicholas
Spiro, managing director of Spiro Sovereign Strategy.
In a statement, Spain's Treasury said the downgrade
reflected a short-term reaction to negative euro zone debt
markets, rather than a change in medium and long-term economic
fundamentals, adding that the government remained committed to
fiscal consolidation and reform.
The downgrade was not unexpected and Spanish bond yields
rose only slightly. The 10-year Spanish government bond yield
was 2.5 basis points higher at 5.391 percent in
early European trade.
Madrid has imposed a deficit target on all 17
regional governments of 1.3 percent of GDP for this year, but
many of them are expected to overshoot, pushing up the overall
Moody's warned that worsening growth prospects for the euro
zone will make it more challenging for Spain to reach its fiscal
targets and said it continues to have serious concerns about
regional governments' funding situation.
"Not all the regions are the same. But we do think the
regions will deviate from the aggregate (deficit) target for
this year," Kathrin Muehlbronner, senior analyst for sovereign
ratings at Moody's, told Reuters by telephone on Wednesday.
Since Moody's placed Spain's rating under review in late
July no credible resolution of the sovereign debt crisis has
emerged, and it will take time for confidence in the area's
political cohesion and growth prospects to return, Moody's said
in a report.
"Moody's threatened to downgrade us by one notch
in July, we enshrined a spending cap in the constitution and
adopted various fiscal consolidation measures and now they
downgrade us by two notches. We can't agree with them on this,"
an Economy Ministry spokesman said.
The downgrade puts more pressure on euro zone leaders, who
will meet this weekend to discuss how to resolve the crisis.
"If the euro zone can't figure a way to handle the
situation, you are going to see Spanish yields continue to go
up, and they are going to have a problem funding themselves,"
said Jessica Hoversen, currency and fixed income analyst at MF
Global in New York.
SPAIN REFORMS WELCOMED
Moody's move on Spain follows its recent downgrade of
Italy's sovereign rating, to A2 with a negative outlook.
Moody's Muehlbronner, however, said Spain's efforts on
reform of its pension system, the labour market and the
financial sector, and other measures, had boosted its credit
worthiness compared with that of Italy.
With Spanish elections due next month, Moody's will be
monitoring the new government's actions and its commitment to
fiscal consolidation, Muehlbronner said, welcoming recent
cross-party support on the need to achieve fiscal consolidation
and a balanced budget.
In August, the ruling Socialists and the centre-right
opposition People's Party (PP) reached an agreement to establish
limits on the public deficit and debt as part of the
The PP are expected to win a landslide victory at the Nov. 20