All eyes will be on Spanish prime minister Mariano Rajoy this week as he battles desperately to dampen speculation that his country will be next in line for a bailout.

Despite suffering a surprise setback in a regional election on Sunday, and the prospect of a general strike on Thursday, Rajoy is adamant that his 2012 budget, due to be unveiled on Friday, will be a "very, very austere budget”.

Spanish bond yields have risen sharply in recent weeks after Rajoy attempted to get around European Union rules by relaxing his deficit target to 5.8 per cent of GDP in 2012, from the previous target of 4.4 per cent. After tense negotiations with Brussels a revised target of 5.3 per cent was agreed.

All the same, many economists believe that Spain’s dismal economy will make it near impossible for Rajoy to meet his revised deficit. The country is slipping deeper into recession, unemployment is rising, and the problems in the Spanish banking sector are being exacerbated by further steep declines in housing prices and growing loan defaults by businesses and households. They argue that harsh austerity measures will only serve to deepen the economic downturn, causing tax revenues to collapse even further.

In a recent note, GaveKal analyst Francois-Xavier Chauchat points out that Spain is currently grappling with two long-festering problems – ballooning regional debt levels and unrecognised bank losses. These twin problems, he says, threaten to turn the country into the next eurozone bailout country "unless debt rationalisation comes to the rescue.”

Chauchat points out that the Rajoy-led government that came to power in December inherited a worse-than-expected deficit of 8.5 per cent of GDP, which was well above the 6 per cent target. The higher deficit, he notes, was largely due to a blowout in regional and local government deficits.

At the same time, Spain is having to face up to the consequences of the collapse of its property bubble. In February, the Rajoy government forced banks to make an extra €50 billion ($US66.6 billion) in provisions to cover their troubled property loans.

But with the economy falling back into recession, and land prices plunging, Chauchat believes that this will not be enough. "We estimate another €25-50 billion will need to be added to €50 billion imposed in February and the €66 billion of specific provisioning done over the 2008-2011 period.”

Even worse, the Spanish banking system appears to be just at the beginning of a huge deleveraging process. "It is generally estimated that the loan book of Spanish banks and cajas [unlisted savings banks] will need to decline by €300-400 billion over the coming years, or 20 per cent of the total loans outstanding.”

Of course Spanish banks, and the Spanish bond market, have been huge beneficiaries of the €1 trillion flood of liquidity released by the European Central Bank through its longer-term refinancing operations.

According to Chauchat, by the end of February the ECB provided €152 billion in loans to Spanish banks. By January, the Spanish banks had used this money to buy €52 billion of Spanish government bonds.

Meanwhile, the ECB also snapped up around €50 billion of Spanish government bonds between August and November last year. As Chauchat notes, this means that "directly and indirectly, the ECB has thus already de facto bailed out Spain by at least €100 billion.”

This ECB largesse has allowed Spain to reduce its dependence on foreign investors. At the end of 2008, more than 50 per cent of Spanish bonds were held by foreign investors, now it's down to less than 25 per cent – or around €150 billion.

As a result, if Spain did need a bailout, Chauchat calculates that it would only need around €200 billion: €150 billion to cover the debt held by foreign investors, plus around €60 billion for its banks. This shouldn’t be too difficult for the eurozone’s new firewall, which should have a capacity of around €750 billion.

All the same, Chauchat believes that the eurozone will be keen to avoid a Spanish bailout as it "would risk opening another very painful episode in the euro crisis.”

He argues that we may be close to the point where Spain has re-nationalised enough of its debts to avoid a major sovereign debt crisis that would rattle eurozone financial markets.

But he adds the warning that Spain will clearly need "lasting and possibly increased support from at least the ECB in order to maintain a firewall between its ailing banking sector and its public finances.”

More from Business Spectator


Please login or register to post comments

Comments Policy »
Hi Karen, some points are well done others not so (Sidestepping a Spanish crisis, March 28). For example:
1. The ECB has accepted junk from Spain and as a result the ECB will have problems once the Spanish bonds become non performing.
1a) Hence Merkel's acceptance to increase the firewall.
2. So far the present funds are light and only have about $250 billion ready and able to go.
2a) Several EU countries have refused to add to and some can't.
2b) Germany so far has not put in more.
The point about the ECB will require some focus in the coming months as the totality of what Draghi has done becomes apparent.
And lastly, our own RBA will drop interest rates by 1 per cent next week, as why.
The ECB has become the de facto source of euro bank funds (Sidestepping a Spanish crisis, March 28).
This is to supposedly to stop the real estate prices imploding which would make the banks insolvent.
If the ECB had just enforced a 5 per cent interest rate in the beginning and told Greece to go to hell, none of this mess would have happened.
Saving the banks will not save the governments. The deflation of real estate will continue. The lowering of tax revenue will go down with the real estate price and the lack of construction activity. The pain is extended by saving the bankers.
Houses that are too expensive are not affordable by immigrants. Better that these banks get nationalised and a firesale of bank assets occurs. A house that gets sold for $1 still creates taxable activity.
It's time for the ECB to work for Europe. If a bank cannot meet its obligations it should be nationalised, the board removed and most of its employees made redundant.
Unless the underlying structural deficits are addressed this fabulous magic pudding of the ECB's will soon need another 0 added to the right hand end (Sidestepping a Spanish crisis, March 28).
I wonder what the effect will be on EU stability, given that such political capital has been effectively (well not very) spent on papering over the symptoms, when the causes of the situation must be addressed.
Very well reported Karen. Thanks for the detail (Sidestepping a Spanish crisis, March 28).
We can clearly see what will transpire though over the next forward period. These Euro supporters are living in a dream world and I agree with Tony Holland (March 28, 9.23am) except in his last point and only because I don't think the RBA has a clue what is required or what they are or indeed, should be doing. They are out of their depth and probably because they don't exist in the real world.
Regarding the eurozone situation, simply put: anything pretty much information and decision wise that comes out of Europe pertaining to the euro will be flawed very badly (though not in the reporting). This entire euro situation should have been wrapped up a couple of months ago or sooner by simply doing the numbers and deciding on evidence based that the euro should be disbanded/and buried for all time as an interesting but very fundamentally flawed idea that is impossible to work with over the long term. No reinvention or modification to make it work will in fact not work because of the ever volatile nature of the membership of its member states and the politics surrounding them.
When I first saw the heading of this article I thought Karen is the bearer of good news (Sidestepping a Spanish crisis, March 28). Unfortunately, it wasn't to be. Europe and the euro are still a mess and as others point out likely to disintegrate. For any one who has travelled through the eurozone this is a real pity as the bugbear of having to change currencies at each border is a real pain particularly in the rear pocket where you invariably get ripped off by the money changers.
That there is a severe financial crisis in Spain and that the country now is in recession is obviously a real problem for Spain and its people. However, every crisis provides opportunities and if one was to study the Spanish bourse one would find many companies with fairly attractive valuations e.g. below book market valuation (Sidestepping a Spanish crisis, March 28).
What is a surprise to me and probably other is how passive Australian companies are on the world scene. Now, with a high Australian dollar and low company valuations is a prime time to invest in overseas companies e.g. in Europe.
Regarding Tony suggesting the RBA should drop rates by 1%, would this not hurt a lot of retirees who supplement their income with interest from bank deposits? For every person with a loan who would benefit from lower rates, there's another person (or more), who would be hurt. Do all our ills require lower rates? Or perhaps where they are now is about right? (Sidestepping a Spanish crisis, March 30).