Fitch Ratings has slashed its ratings on Spain by three notches from A to BBB, citing the cost of restructuring its banking sector, the government’s financial position, and its weak economy.

The rating agency said Thursday that its downgrade of Spain’s sovereign ratings reflects the likely fiscal cost of restructuring and recapitalizing the Spanish banking sector, which it estimates to be around €60 billion (6% of GDP), and could go as high as €100 billion in a more severe stress scenario, up from its previous estimate of €30 billion.

It also says that gross general government debt is now projected to peak at 95% of GDP in 2015, assuming a €60 billion bank recapitalization, compared to Fitch’s forecast at the beginning of the year of 82% by the end of 2013. And, it says the country’s high level of foreign indebtedness has left it especially vulnerable to contagion from the ongoing crisis in Greece; and is constraining its ability to intervene decisively in the restructuring of the banking sector.

Additionally, Spain is forecast to remain in recession through the remainder of this year and 2013 compared to Fitch’s previous expectation that the economy would benefit from a mild recovery in 2013.

“The dramatic erosion of Spain’s sovereign credit profile and ratings over the last year in part reflects policy missteps at the European level that in Fitch’s opinion have aggravated the economic and financial challenges facing Spain as it seeks to rebalance and restructure the economy,” it says.

“The intensification of the eurozone crisis in the latter half of last year pushed the region and Spain back into recession, exacerbating concerns over sovereign and bank solvency. The absence of a credible vision of a reformed EMU and financial ‘firewall’ has rendered Spain and other so-called peripheral nations vulnerable to capital flight and undercut their access to affordable fiscal funding,” Fitch notes.

On the upside, Fitch says Spain’s investment grade status remains supported by a relatively high value-added and diverse economy, and political and social stability, despite high unemployment. Competitiveness and export performance are improving, it notes, and the trade balance on goods and services is expected to post a surplus this year.

The rating is also supported by the Spanish government’s commitment to wide-ranging structural reform to improve the efficiency of public services and strengthen the budgetary and fiscal framework; enhance the flexibility of the labour market; and foster competitiveness and the growth potential of the economy, it adds.

Nevertheless, the outlook on Spain’s sovereign ratings remains negative, indicating a heightened risk of further downgrades, primarily reflecting the risks associated with a further worsening of the eurozone crisis.