More Color on Spain

The market continues to digest the meaning and implications of Moody's decision to cut its rating to Aa2 from Aa1. The two main considerations behind Moody's decision are that the cost to restructure the banks will be greater than Spanish officials have estimated and the sustainability of current austerity measures.

At 40-50 bln euros, Moody's new estimate is more than twice the estimate it had made late last year and is well above the government's estimate. Moody's downgrade of FROB, which is the government arm that is to help raise the funds for the bank restructuring. The ECB was quick to point out that FROB has the capacity to provide as much as 90 bln euro in funding. What was not said was that like the EFSF, FROB is not pre-financed. That as banks request funds, it needs to raise them by issuing bonds and will then in some ways compete with the government in the capital market.

Ambitious fiscal targets are being met, but Moody's concerns are two-fold. First that the measures tend to rely on cuts in capital spending and wage freezes, both of which by definition are not sustainable. Second, Spanish regional governments enjoy a high degree of autonomy and fiscal discipline has been more elusive. A little than half the 17 autonomous regions overshot their fiscal targets last year. To be sure, Moody's continues to suggest that Spain will not have to tap into the EFSF.

Just like Irish per capita GDP remains above Germany, Spain's debt/GDP ratio last year was lower than Germany (and France and the UK) and if Moody's figures are close to the reality, Spain will still have a lower debt/GDP than Germany this year. Later today Spain's cental bank is expected to provide a more detailed accounting of the bank/cajas recap needs.