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Finance
 
BEST OF B&E 2011 "SPAIN: SOVEREIGN DEBT CRISIS – PUBLISHED IN B&E ISSUE DATED MAY 12, 2011"
Can Spain avert Portugal’s fate?
Like the three eurozone members that have sought assistance, Spain faces big economic challenges. In fact, the recent recession, property market correction, and high unemployment have all taken their toll on the country’s public purse. Can Spain avoid following Portugal, Ireland and Greece?
Issue Date - 19/01/2012
 
Tension has escalated in the European bond markets after Portugal finally bowed to the ongoing sovereign debt crisis and requested for an emergency financing from the European Union (EU) during the first week of April 2011. As financial markets had similarly forced Greece and Ireland to seek monetary help from the EU and IMF last year, economists have now started fearing that the recent bailout request from Portugal makes it more likely that other eurozone members will follow suit, and soon. But then, the question is: Who will fall next?

The last of the four PIGS (an acronym used by international bond analysts that refers to the faltering economies of Portugal, Ireland, Greece and Spain; the other three have already faltered), we would say! Reason: Spain’s recovery has been really rough so far. In fact, the eurozone’s fourth-largest economy is among the area’s laggards. While the entire monetary union saw GDP grow by 1.7% last year (with Germany racing ahead at 3.5%, the fastest in the eurozone), Spain’s economy contracted 0.1% in 2010. At 20.5%, Spain’s unemployment rate too is the highest in the area, and almost double of Portugal’s 11.1%, the latest victim to the debt crisis. But then, are these reasons good enough to predict Spain as the next European Domino?

The Banco de España – Spain’s Central Bank – diplomatically ducked our queries and told B&E, “As central bank we do not usually give answers to questions of this kind, especially the questions related to the eurozone debt crisis.” It’s both surprising and amusing to get such a response, given the increasing negativity in global markets about Spain (Enam Ahmed, the London-based Sr. Economist at Moody’s Analytics, tells B&E, “Like the three eurozone members that have sought assistance, Spain faces big economic challenges. Spain has a large fiscal shortfall to finance. Its recent recession, property market correction, and high unemployment have all taken their tolls on the public purse. In fact, the country is likely to slip back into recession in 2011”).

The signals sent by Spain are almost similar to the ones propelled by Greece, Ireland and Portugal just before they collapsed. Like its aggrieved Euro-partners, Spain too has a fragile public finance. Though Spain’s fiscal deficit narrowed last year, it still remains at 6.2%, which is almost double the fiscal ceiling (3% of GDP) set by EU. Even the country’s public and private foreign liabilities at $2.4 trillion (of this total, about $1.2 trillion are owed to foreign holders by Spanish banks & other private financial institutions, while about $700 billion are owed by private companies and individuals. The public sector owes $450 billion to foreigners) are close to 170% of its GDP ($1.3 trillion), much higher when compared to the other three beleaguered nations. For instance, foreign liabilities of Greece stood at 87% of its GDP at the time of the collapse.

Considering this, the 10-year yields on Spanish bonds are hovering at 5.3%, and are expected to only move north. No doubt, yields on 10-year Spanish government bonds are still comfortably below the yields on their Portuguese (10.02%), Irish (9.72%) and Greek (12.4%) equivalents and as such gives Spain some breathing space. But then how long? Yields on 10-year Spanish government bonds are already 180 basis points higher than their German equivalents which give prudent investors a reason good enough to stay away from Spain. This certainly makes the situation difficult for Spain, which has about $440 billion worth of debt to refinance in the next six years.

 
A banking sector with pockets of weakness also raises concerns, as the government may need to pump more money into the sector to restructure in. Reason: The steep correction in the prices of real estate, to which local banks have heavy exposure, has spurred a wave of asset write-downs among Spanish banks. While profitability of the banks has plunged due to restructuring, high credit default swap spreads (230 bps) have raised investors’ doubts on the sector’s solvency, particularly the local savings banks, or cajas. In fact, Spanish officials estimate that the cost of recapitalising and restructuring just cajas could total $24 billion, leave aside national level banks.

No doubt, for the EU, Spain is too big to be allowed to fail, but then at the same time isn’t it too big to save? In fact, a bailout of Spain would require more than $600 billion, way above the $390 billion needed to rescue Greece, Ireland and Portugal together. If Spain requests rescue, the move will not only eat up more than half of the $1 trillion combined EU-IMF rescue fund, but will also question the long-term sustainability of the single currency area.

Clearly, the Spanish economy is in a difficult situation requiring the pursuit of ambitious and demanding policies to correct the ?scal imbalances. This can only be possible if policymakers move back to the drawing boards to restructure and recapitalise the country’s ?nancial system by focusing on the expenditure side. This will not only strengthen public confidence in the capacity of the government to regain sustainability of public finance, but will also reduce risk premia in interest rates and thus stop the economy from faltering. But then, this needs to be done really fast. For every day this is not done, the costs are going up by hundreds of millions.

Manish K. Pandey           

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