Spain lost its precious Aaa rating as Moody’s downgraded its sovereign debt one notch to Aa1. The agency said the outlook for the new rating is stable.

Moody’s gave three reasons for the downgrade. The first was the weak economy, which may take years to rebuild, particularly its construction and real-estate sectors. The second is a sharp drop in the central government’s financial strength and balance sheet. The final reason Spain’s cost to borrow money in the global capital markets has continued to rise is that the risk of default has now grown considerably.

Spain has an unemployment rate of nearly 20%. Despite austerity measures, it will need to finance its deficit and national debt for many years, based on a number of forecasts by outside observers which include rating agencies and global organizations such as the IMF.

“One of the key drivers for Moody’s decision to downgrade Spain’s rating to Aa1 is its weak growth prospects and the challenge that this presents for fiscal consolidation,” says Kathrin Muehlbronner, a Moody’s Vice President–Senior Analyst and lead analyst for Spain.

Moody’s expects Spain’s GDP growth rate to be no better than 1% for the next five years.

Spain faces problems that could worsen its already anemic financial stability quickly and these were not part of the reasons that Moody’s gave for its action. Labor strikes throughout Europe threaten austerity programs meant to bring down deficits. The expense reduction plans, often coupled with higher taxes, may make sense on paper, but if there is considerable resistance from voters, the programs could turn out to be worthless. This has not been taken into account to the extent that it should be as analysts look at the future of Europe’s finances.

Recent general strikes in Europe brought out tens if not hundreds of thousands of protesters, many from unions and groups of public workers who face pay cuts. A general strike in Spain caused clashes with police. Nearly 100,000 people streamed into the streets of Brussels and there were also labor strike in Ireland and Greece.

The most acute threat to Europe’s sovereign debt now is not the will of legislators and government ministers to adopt budgets which are more acceptable to the European Central Bank and eurozone officials. Angry citizens may begin to vote out the politicians who cut worker compensation. New legislators may decide that the will of citizens is to keep public expenditures high. The back of austerity will be broken by the electorate.

The sovereign debt issues in Europe are far from over and will not come close to a resolution until they gain a broad acceptance from workers who can harm GDP growth and unsettle elected officials.

Douglas A. McIntyre

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