WASHINGTON (MNI) – The following text is a summary of an report
published Tuesday by Standard & Poor’s on its ratings rationale for
Spain:

The ratings on Spain reflect the benefits of what we view as a
modern and relatively diversified economy, as well as our opinion of the
government’s continuing political resolve to deal with the outstanding
challenges, as reflected in a significant acceleration in both budgetary
consolidation and the structural reform effort since 2010. Moreover,
Spain benefits, in our opinion, from its moderate (albeit increasing)
general government debt. Nevertheless, we believe that the ratings will
remain under pressure from what we deem to be high private-sector
indebtedness, challenges to the economy’s competitiveness, persistently
difficult labor market conditions, and the economy’s weak net external
financial position.

Following the 0.1% contraction in GDP we estimate for 2010, we
anticipate that the economy will return to positive growth rates of
approximately 0.7% in 2011 and 1.5% in 2012. This recovery, in our
opinion, is subject to significant downside risk due to a combination
of: the private sector’s continuous deleveraging; what we consider to be
restrictive fiscal policies; limited growth prospects, in our opinion,
on the back of the global economic recovery; persistently high
unemployment; financial-sector stress; and large net external debt (we
forecast a level equivalent to 78% of GDP in 2011). We believe that
these factors make the economy vulnerable to sudden shifts in external
financing conditions, possibly complicating the country’s economic
recovery.

In an unfavorable economic climate in 2010, the government put in
place what we view as a substantial reform effort, including a
front-loaded budgetary consolidation strategy and a comprehensive set of
structural reforms. We estimate that the 2010 general government deficit
target of 9.3% of GDP was met, on the back of the government’s fiscal
package involving tax hikes and spending cuts.

This is mainly due to the significantly better-than-expected
central government deficit (5.1% of GDP versus a planned 5.9%), more
than compensating for the slippage at the local and regional government
level. We anticipate that the general government deficit will decline to
6.3% of GDP in 2011, broadly in line with the government’s target of
6.0%, and to 5.1% of GDP in 2012. The difference between our 2011
forecast and that of the government is attributable to our lower
forecast of underlying economic growth, and its impact on the budget.

As a result, we forecast an increase in net government debt to
61.6% of GDP in 2011 and 65.0% in 2012, from an estimated 56.2% in 2010.
Further growth in borrowing costs could result in higher interest
outlays than the government currently plans, although the increase in
the average interest rate on Spain’s outstanding government debt in 2010
was negligible (3.69%, versus 3.53% in 2009 and 4.32% in 2008)–despite
negative market sentiment–thus limiting the potential additional burden
on the budget. Our current government debt projection does not include
the anticipated income from the announced partial privatization of the
airport operator AENA and the National Lottery. Similarly, it does not
include potential additional capital injections by the state to further
strengthen the financial sector.

In our opinion, such costs could surpass 20 billion–a level
recently mentioned by the government–with the excess driven either by
higher-than-expected losses in financial institutions’ property-related
loan portfolios; failure of financial-sector entities involved in
integration processes to reduce their operating expenses; or higher
funding costs, since, in our opinion, the financial sector’s approximate
760 billion of gross external debt at year-end 2010 leaves it
vulnerable to exogenous shocks.

We believe that in the medium to long term, the recently adopted
pension reform program, if fully implemented, will likely lead to
important savings in social security outlays. The reform program
includes increases in the retirement age–to 67 for standard retirement
and 63 for early retirement–an extension of the pension calculation
period to 25 years from 15, and the introduction of a “sustainability
factor” linking the financial sustainability of the pension system to
the future evolution of life expectancy. While it is too early, in our
view, to assess the impact of labor reform on Spain’s economic growth
prospects, we believe that the reform measures implemented to date are a
step in the right direction, though stopping short of a fundamental
overhaul of the labor market. Additional labor reform measures planned
by the government for the first quarter of 2011 in the areas of active
market policies and collective bargaining procedures could, however,
further reduce some of the structural rigidities that we believe
constrain labor demand in the economy. Outlook

The negative outlook reflects the possibility of a downgrade if
Spain’s fiscal position deviates materially, in our opinion, from the
government’s budgetary targets for 2011 and 2012. A downgrade could also
occur if the impending correction in private-sector leverage results in
what we would consider to be a disorderly adjustment in the financial
sector, leading to a sharper deterioration of the Spanish government’s
balance sheet or lower economic growth than we currently anticipate,
possibly coupled with resurging deflationary pressures. Moreover, we
could lower the rating if vulnerabilities persist related to external
financing conditions or delays in the implementation of structural
reforms.

Conversely, we could revise the outlook to stable if the government
meets or exceeds its budgetary objectives in 2011 and 2012, risks to
external financing conditions subside, and Spain’s economic growth
prospects prove to be more buoyant than we currently envisage as a
result of a smooth economic adjustment and restructuring process.

** Market News International Washington Bureau: 202-371-2121 **

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