MADRID Ratings agency Moody's put Spain on review for a possible downgrade on Wednesday, highlighting concerns over a looming funding crunch next year and prompting the euro and bank shares to slide.
However, the agency said it did not expect Madrid to have to resort to a European Union bailout as Greece and Ireland have.
"Moody's does not believe that Spain's solvency is under threat and in its base case assumptions does not expect the Spanish government to have to ask for EFSF liquidity support," Moody's lead analyst on Spain Kathrin Muehlbronner said.
"However, Spain's substantial funding requirements, not only for the sovereign but also for the regional governments and the banks, make the country susceptible to further episodes of funding stress," she said in a statement.
Spain's government has slashed spending to reduce its high deficit, reformed labor laws, forced weak savings banks to merge and announced state asset sales to try to calm market fears over its finances.
But investors fear financial trouble still looms due to banks' exposure to bad loans from Spain's burst real estate bubble and high deficits run by autonomous regional governments.
Spain's government faces a bond redemption at the end of April of 15.5 billion euros while its banks will be looking to refinance around 35 billion euros in the Spring.
Economy Minister Elena Salgado said Moody's rating review did not cast doubt on the country's solvency.
"I expect that within three months we shall be able to offer sufficient arguments to turn that negative outlook into positive," she told reporters as she left a hearing in Congress.
A pre-Christmas market lull may have taken some of the heat out of the euro zone debt crisis but the ratings agencies have flagged risks are unabated in 2011, and could be spreading.
Standard & Poor's cut its outlook for Belgian debt to negative on Tuesday, saying that if the country's inability to form a government threatened deficit- and debt-reduction goals, its AA+ rating could be cut within six months.
EURO, BANK SHARES HIT
The euro extended the day's losses on the Moody's announcement and Spanish banking shares fell 2 percent as a group, led by the euro zone's biggest bank Santander which was down 2.1 percent at 8.2 euros.
Spain's risk premium, as measured by the spread between yields on Spanish and German benchmark bonds rose to around 260 basis points, still well under a late-November high over 300 basis points.
Spain paid over 100 basis points more to sell its treasury bills at an auction on Tuesday compared with last month, and yields are also expected to rise at a bond auction on Thursday.
Moody's, which has an Aa1 rating on Spain, cited the country's vulnerability to funding stresses, weak market confidence and the possibility of greater public debt should the banks need further capitalization.
"(Moody's cites) issues that have been on the radar screens for quite some time, but nonetheless at this particular juncture it does have the potential to generate more negative impact on market sentiment," said Nick Matthews, economist at RBS.
"There's been a question mark over the need to capitalize the banking sector for quite some time now."
Earlier this week, Moody's kept its negative outlook on Spain's banks and said they would need to recapitalize by an extra 17 billion euros on the basis of a minimum 8 percent Tier 1 capital ratio after conservative one-year earning estimates were taken into account.
Spain's sovereign debt lost its last top-line triple-A rating on September 30 when Moody's became the last of the main three ratings agencies to downgrade it by one notch.
It has been under intense scrutiny from international markets since Ireland was forced to take a 85-billion euro aid package in November on worries over similarities between the countries' property bust and banking systems.
The government has denied it would also need to apply to the European Financial Stability Facility (EFSF) and rejected any comparison between its economic position and Ireland's.
"Moody's ... continues to view Spain as a much stronger credit than other stressed euro zone countries," the ratings agency's statement said. "This is reflected in the significantly higher rating for the Spanish sovereign.
(Additional reporting by Elisabeth O'Leary, Sonya Dowsett and Rodrigo de Miguel; Editing by Fiona Ortiz and Mike Peacock)