Spain's Prime Minister Mariano Rajoy, left, and French President Francois Hollande, sign cooperation agreements during a Franco-Spanish summit at the Elysee Palace, in Paris, Wednesday, Oct. 10, 2012. (AP Photo/Philippe Wojazer, Pool)
Spain's Prime Minister Mariano Rajoy, left, and French President Francois Hollande, sign cooperation agreements during a Franco-Spanish summit at the Elysee Palace, in Paris, Wednesday, Oct. 10, 2012. (AP Photo/Philippe Wojazer, Pool)
Spain's Prime Minister Mariano Rajoy, left, and French President Francois Hollande leave after a news conference following a Franco-Spanish summit at the Elysee Palace, in Paris, Wednesday, Oct. 10, 2012. (AP Photo/Christophe Ena)
MADRID (AP) ? The dilemma facing the Spanish government has become more acute following a downgrade of the cash-strapped country's credit rating.
Late Wednesday, Standard & Poor's cut its rating on Spain's debt by two notches to BBB-, leaving the country on the cusp of junk status. That's important because it potentially makes it more expensive for the Spanish government to borrow money.
As well as citing the deepening economic recession in Spain and rising levels of social discontent, the agency said the government's "hesitation" in requesting help was "potentially raising the risks to Spain's rating."
Though S&P's warning may nudge the Spanish government to make a bailout request sooner than later, rival agency Moody's has indicated it may cut its rating on Spain in the event of a bailout request.
"It would appear that when it comes to the rating Spain is a bit between a rock and a hard place," said Gary Jenkins, managing director of Swordfish Research.
Financial markets responded negatively Thursday to the overnight developments and Spain's main IBEX stock index was underperforming its counterparts in Europe, trading 1 percent lower in early trading. Meanwhile, the yield on the country's 10-year bond spiked 0.10 percentage point higher to 5.88 percent, an indication of mounting investor unease.
Last month, the European Central Bank announced a new plan to keep a lid on the borrowing costs of indebted countries like Spain. It said it would buy unlimited amounts of debt of struggling European countries. However, the governments first need to apply for bailout and so far the Spain's has balked at the prospect.
Instead, the government, led by Prime Minister Mariano Rajoy, has introduced a series of austerity and labor measures in a bid to bring down its deficit and convince investors it can manage its finances without outside help.
If the Spanish government continues down that path, it will have to do so with a debt rating, near, or even, below junk status.
Though it has raised around 90 percent of the money it needs to service its debts in 2012, Spain will soon be confronted with the prospect of having to tap investors for around ?200 billion ($258 billion) in 2013.
"Not easy to raise that kind of money with that kind of rating when the economic data is likely to come in worse than government forecasts," said Swordfish's Jenkins.
Earlier this week, the International Monetary Fund forecast that the Spanish economy would contract 1.3 percent next year, more than double the Spanish government's own prediction.
Following discussions with French President Francois Hollande on Wednesday, Rajoy said the country was making important reforms and that those, combined with European solutions, would prove the IMF wrong.
"If we follow that strategy ... we'll see that the reality turns out to be better than the forecasts," Rajoy said.
The prevailing view in the markets remains that Spain will have to request outside help some time next year, possibly after regional elections later this year, given the scale of the task in hand.
"With a large proportion of their funding for the year already completed we expect them to have sufficient funds to hold out until regional elections are out of the way later this year, though redemption payments at the end of January may become uncomfortably costly to refinance if yields drift wider," said Elisabeth Afseth, an analyst at Investec.
Christine Lagarde, the head of the IMF, praised recent steps taken by the ECB and European governments, but voiced her concerns at the impact Europe's austerity drive was having on global growth. Earlier, this week the IMF downgraded its global growth estimates for this year and next.
Spain, alongside many other European countries, have slashed spending and raised taxes in order to get a handle on their debts and in an attempt to convince investors they have a strategy to get their house in order.
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Pylas reported from London.
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