Spain lost its final top-line debt rating on Thursday as the government sought backing from lawmakers for a budget it hopes will be austere enough to convince markets it can slash the deficit at a time of economic weakness.
Moody's become the third and last rating agency to cut Spain out of the highest AAA category which has helped it finance its debt relatively cheaply. The one-notch cut had been expected and the agency said it hoped not to have to cut again soon, bolstering Spanish debt markets.
But the agency also said a poor growth outlook meant Madrid would have to take further steps to meet its deficit targets in years to come. The Bank of Spain said a sluggish recovery would slow further in the third quarter.
"A large part of the fiscal consolidation for this year and next is based on tax increases and measures that cannot be continued for many years," Moody's lead analyst for Spain, Kathrin Muehlbronner, told Reuters.
"Spain will need more structural measures to bring down its deficit."
The government has slashed public spending in the euro zone's fourth biggest economy, hoping to differentiate itself from Greece, Ireland and Portugal as investors punish sovereign bonds from high-deficit countries on the periphery of the euro zone.
Millions of Spaniards joined a general strike on Wednesday to protest against public sector cutbacks — the budget envisages a 7.9 percent cut in spending for next year –, labour reforms aimed at making it easier for companies to hire and fire, and plans to extend the retirement age to 67 from 65.
Details from the 2011 budget showed a planned cut in net debt issuance next year to 43.3 billion euros from 76.2 billion euros this year. However, interest paid on the state's debt in 2011 would rise to 27.4 billion euros, or 2.5 percent of GDP.
Economy Minister Elena Salgado told a news conference after presenting the budget to lawmakers that she expected Spain to be able to continue issuing debt at "very reasonable" cost, and that it would press on with its austerity plans.
Echoing many economists' view that budget cuts will push Spain back into recession this year, Moody's forecast average economic growth of just 1 percent over the next few years as Spain tries to rebuild its property-dependent economy.
SPANISH SPREADS NARROW
Socialist Prime Minister Jose Luis Rodriguez Zapatero's minority government is expected to pass the budget before the end of the year, having secured the backing of the Basque National Party earlier this month in return for some concessions to autonomy in the Basque region.
The government also maintained a growth forecast of 1.3 percent for 2011 expansion of gross domestic product next year.
After the Moody's announcement, Economy Secretary Jose Manuel Campa told Reuters the government was satisfied with the agency's assessment of Spain's fiscal measures as achievable this year.
But he criticized Moody's view on growth.
"We believe that outlook is excessively pessimistic," he said.
The spread in Spain's 10-year bond yields over benchmark German debt narrowed about five basis points from a day earlier, to 191 bps.
The comparable spreads on Irish and Portuguese benchmark bonds have soared to well beyond 400 basis points on concerns over looming credit problems in those two countries.
Spanish stocks <.IBEX> fell 0.2 percent, in line with other European markets.
"The one notch cut (by Moody's was widely expected by the markets. But I would highlight the reference to Spain remaining vulnerable to further market stress, particularly in the context of its debt refinancing needs for 2011 and 2012," Citigroup Economist Giada Giana said.
"I think the growth forecast of an average 1 pct annually for the coming years is still too high. We see 2011 growth close to flat or even negative for next year," she said.
