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Sunday, June 27, 2010
Poor Spain. The euro-crisis spotlight has slowly been shifting from Greece to its much larger and more economically significant Iberian neighbour. Although nowhere near as fiscally irresponsible as Greece, Spain is still smarting from a massive housing bubble blow-up and nearly 20% unemployment. Overall debt to GDP is a reasonable 60%, but much of this is owed to external creditors. Moreover, the annual deficit is closer to 11%, which raises questions about the near-term sustainability of its economic situation. What we've seen elsewhere is that this uncertainty alone is enough to create its own problems.
First, the private sector. Because of this "uncertainty" and their heavy exposure to bad loans in the property sector, Spanish banks have seen their access to wholesale funding markets dry up. In fact, Spanish banks broke an ECB borrowing record last month, suggesting that they are heavily reliant on government financing for their liquidity. Recognizing the dire situation facing its banks, the Spanish government set up the FROB last year to assist with debt restructuring. More recently, the Banco d'Espagna is attempting to stop the panic before it starts through the publication of so-called stress tests of Spanish banks.
In all likelihood, the tests will reveal that Spain's largest banks are quite solvent, thank you very much. The chief of Santander, Spain's largest bank, certainly thinks so (although he would say that, wouldn't he?). The solvency of two other large banks, BBVA and La Caixa, will probably also be demonstrated by the tests. But solvency isn't the issue; liquidity is. Until investors are convinced that Spain is not going the way of Greece, their banks will struggle to access funding.
Which brings us to the public sector. In my view, there is likely a greater danger facing Spain's national balance sheet than for its banks and corporations. This is in part because of the combination of problems facing the nation and the fact that Spain has been slow to demonstrate its resolve in addressing them. Perhaps reflecting this, the spreads are wider on Spanish government debt than on Banco Santander and a large Spanish telecoms firm.
As noted above, the combination of nearly 20% unemployment and an 11% deficit represents a particularly acute problem for the government. After several meetings with the ECB and other European leaders, Spain's leadership has finally acknowledged the severity of the situation and is acting accordingly: austerity measures have been introduced, including cuts to public sector pay and pensions, and the government just recently decreed reforms for the labour market, which the Spanish parliament has since ratified.
Predictably, the public sector union staged protests in response to the cuts. I was in Barcelona for the June 8th protests (see photo below), and had several impressions. First, the protests were quite civilized - certainly nothing compared to the earlier madness in Athens. But they were also quite tame. Indeed, according to The Economist, the turnout was far lower than the numbers threatened by the public sector union.
As noted above, the combination of nearly 20% unemployment and an 11% deficit represents a particularly acute problem for the government. After several meetings with the ECB and other European leaders, Spain's leadership has finally acknowledged the severity of the situation and is acting accordingly: austerity measures have been introduced, including cuts to public sector pay and pensions, and the government just recently decreed reforms for the labour market, which the Spanish parliament has since ratified.
Predictably, the public sector union staged protests in response to the cuts. I was in Barcelona for the June 8th protests (see photo below), and had several impressions. First, the protests were quite civilized - certainly nothing compared to the earlier madness in Athens. But they were also quite tame. Indeed, according to The Economist, the turnout was far lower than the numbers threatened by the public sector union.
But even in the face of such half-hearted protests, it's unclear how far Zapatero's government is willing to go. Elected with a left-leaning mandate, they have been reluctant to cut back government benefits and create a more competitive labour market, caving only in the face of potential financial sector chaos. Moreover, according to some of the locals in Madrid who I spoke with, domestic support for the government is very low. The opinion polls seem to support this. Although the opposition is benefiting from the unpopularity of the austerity measures, according to the (tiny) sample I spoke to, few people think they would do a better job.
All of this suggests that the economy of Spain is facing a grim time ahead, full of uncertainty. For the biggest Spanish banks, the publication of the results of the central bank's stress tests and their ongoing access to the FROB may be enough to calm jittery investors in the short term. I suspect, however, that the stress tests on Spain's reluctant government and the ECB have only just begun.
