Rating agency Standard & Poor's said Wednesday that it now rates Spain's sovereign debt as BBB-minus, one notch above junk status.
The decision to downgrade the rating by two notches, from BBB-plus, was based on the deepening of Spain's economic crisis, marked by rising unemployment and fiscal restrictions that make it difficult for the government to take any steps to spur growth, S&P said.
S&P also cited doubts about the determination of other European Union members to fully share the costs of shoring up troubled Spanish banks and pointed to the lack of a clear direction in the policies of the eurozone.
"In our view, the capacity of Spain's political institutions (both domestic and multilateral) to deal with the severe challenges posed by the current economic and financial crisis is declining," S&P said.
The rating agency predicted that the results of upcoming regional elections in three of Spain's autonomous regions will likely limit the political options of the central government.
S&P analysts also expect the Spanish economy to continue contracting through 2013 and said that the recent increase in exports is not enough to compensate for the sharp decline in domestic demand, which is reflected in falling tax receipts.
Spain is in recession for the second time in three years in large part due to the collapse of a long-building housing bubble, which left many of its banks saddled with toxic real-estate assets.
With its borrowing costs soaring, the country was forced to request a loan of up to 100 billion euros ($129 billion) from its eurozone partners to prop up those ailing financial institutions.
The Iberian nation's unemployment rate currently stands at nearly 25 percent overall and more than 50 percent among young people.
Numerous businesses have failed amid the slump and tens of thousands of families have been evicted from their homes after falling behind on their mortgages.
Efforts to comply with EU targets for reducing the budget deficit could prolong Spain's recession, S&P said. EFE