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Spain downgraded by S&P

October 10, 2012: 6:22 PM ET

Standard & Poor's lowered its credit rating for Spain on Wednesday, in a move that could complicate Madrid's effort to avoid requesting a financial bailout.

S&P cut Spain's long-term credit rating two notches to "BBB-" from "BBB+," the ratings agency said in a statement. It also lowered the nation's short-term rating and said the long-term outlook for Spain is negative, meaning it could lower the rate further.

The move reflects the risk of "increasing social discontent" as the Spanish economy slips deeper into recession, according to S&P. It also warned of "rising tensions" between the central government and Spain's semi-autonomous regions.

A growing number of Spain's 17 regional governments have requested bailouts from the central government in Madrid. Catalonia, the largest of region, has threatened to secede.

"Overall, against the backdrop of a deepening economic recession, we believe that the government's resolve will be repeatedly tested by domestic constituencies that are being adversely affected by its policies," said S&P. "Accordingly, we think the government's room to maneuver to contain the crisis has diminished."

Related: Wall Street still spooked by Spain

In addition, S&P warned that the latest plan to recapitalize Spanish banks "still lacks predictability."

Spanish banks need to raise a total of €60 billion to fill the hole left by the bursting of the nation's property bubble, according to a recent audit. Euro area finance ministers agreed in June to provide up to €100 billion in bailout loans to recapitalize Spain's banking sector.

However, S&P said it was unclear whether the loans would add to Spain's debt burden.

Given the uncertainty, S&P said it assumes "that official loans to distressed Spanish financial institutions will eventually fall on the government balance sheet." As such, the agency expects Spanish net general government debt to surpass 80% of gross domestic product in 2013.

The downgrade comes amid widespread speculation that the Spanish government will request a bailout from the new eurozone rescue fund in exchange for potentially unlimited financial support from the European Central Bank.

However, the government of Prime Minister Mariano Rajoy has so far resisted committing to a full-blown bailout program, which could involve mandated budget cuts and outside surveillance.

After rising to unsustainable levels earlier this year, Spain's borrowing costs  have fallen sharply as investors anticipate increased bond buying by the ECB. The drop in Spanish bond yields has made it easier for Spain to delay a request for support from the European Stability Mechanism.

The downgrade means Spain's credit rating is still one notche above speculative grade, according to S&P's ratings scale.

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