NEW YORK (PNN) - October 11, 2012 - Standard & Poor’s downgraded its rating on Spain’s debt Wednesday by two notches, leaving it on the cusp of junk status.

A grinding recession, high unemployment and social unrest are limiting the government’s options for stemming the country’s financial crisis, S&P said.

The credit-rating agency now rates debt issued by Spain BBB-, its lowest investment-grade status. It had been BBB+.

S&P also assigned a negative outlook to the rating, saying it could be further downgraded if Spain’s economic conditions erode further.

“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,” S&P said.

It also cited difficulty in predicting the extent to which other countries in the 17-nation euro zone would come to Spain’s aid. It had previously assumed a key European bailout fund would help recapitalize the country’s shaky banks without piling more debt on the central government in Madrid. But now any recapitalization plan will likely add more debt, S&P said.

Investors are worried that Spanish banks could collapse under the weight of an imploding real estate market.

Tensions between Spain’s indebted regional governments and the central government were also cited by S&P for its downgrade.

S&P estimates Spain’s economy will contract by 1.8% in 2012 and another 1.4% in 2013. Spanish unemployment is near 25%.

Last month, the European Central Bank agreed to buy unlimited amounts of debt by struggling European countries like Spain to help lower their borrowing costs. But the governments first need to apply for bailouts.

Spain has not applied for a bailout yet. Instead, the government 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.

The interest rate, or yield, on 10-year Spanish bonds was 5.78% on Wednesday, near a six-month low. That was down from a July 24 peak of 7.54%, near the level that forced Greece, Portugal and Ireland to seek international bailouts.