Agency cites negative outlook for third downgrade in 13 months

MADRID - Spain's credit rating was cut for the third time in 13 months by Moody's Investors Service as Europe's debt crisis threatens to engulf the nation.

Moody's on Tuesday reduced the country's ranking to its fifth-highest investment grade, cutting it by two levels to A1 from Aa2, with the outlook remaining negative. Standard & Poor's downgraded Spain on Friday to its fourth-highest investment grade, and Fitch Ratings cut it to the same level on Oct 7.

"Moody's is maintaining a negative outlook on Spain's rating to reflect the downside risks from a potential further escalation of the euro-area crisis," the ratings agency said in a statement.

The company cited the "continued vulnerability of Spain to market stress" that is driving up the cost of borrowing, as well as weaker growth prospects. Spanish bonds were little changed.

German Chancellor Angela Merkel said on Tuesday that the upcoming European Union summit on Sunday will mark an "important step", though not the final one in solving the sovereign debt crisis.

"Even if policy action at the euro-area level were to succeed in the short term in returning some degree of normality to bank and sovereign debt markets in the euro area, the underlying fragility and loss of confidence is deep and likely to be sustained," Moody's said.

A meeting of G20 finance ministers and central bankers warned last week that the crisis threatens to endanger the world economy.

"It's imperative that the Europeans do provide a comprehensive framework for addressing the crisis," said Domenico Lombardi, a senior fellow at the Brookings Institution in Washington and a former International Monetary Fund board member.

Failure to do so, he said, will result in a spiral of further downgrades and rising borrowing costs, "which will trigger a fully blown fiscal and banking crisis".

Spain's 10-year bond yield was little changed at 5.36 percent on Wednesday. Even as the European Central Bank has been propping up the bond market since August, Spain pays more than twice what investors demand of Germany to borrow for 10 years.

Spain's rating will face more downward pressure if the government doesn't commit to further measures to reduce budget deficits, Moody's said.

"On the other hand, the implementation of a decisive and credible medium-term fiscal and structural reform plan, coupled with a convincing solution to the euro-area crisis, would trigger a return to a stable outlook," it said.

Spain, the fourth-largest eurozone economy, had the best investment grade possible with all three rating companies in January 2009, when Standard & Poor's was the first to cut.

Moody's said it had lowered its growth forecast for Spain to 1 percent "at best" in 2012, from a previous estimate of 1.8 percent, "with risks mainly to the downside".

Slower growth makes it harder to reduce budget deficits, especially with regional governments likely to miss their targets, the company said.

Growth in Spain slowed to 0.2 percent in the second quarter and Prime Minister Jose Luis Rodriguez Zapatero said on Sept 14 that the quarterly growth rate would remain at similar levels for the rest of the year.

The budget deficit for the general government will reach 5.2 percent of gross domestic product next year, compared with an announced goal of 4.4 percent, Moody's estimated.

Bloomberg News