Why Spain Won’t Regain Market Confidence

Spain is back in the limelight in the EZ crisis, where it has always belonged based on its fiscal, financial and economic fundamentals. Throughout this crisis, the liquidity or solvency of various sovereigns has been determined to a large degree by market sentiment. For Spain’s borrowing costs to recede again to sustainable levels, Spain needs to regain investor confidence. Looking ahead at the calendar of events in Spain and the EZ over the next few months, from where is the good news going to come? The answer isn’t at all obvious.

Bad News Up Ahead for Spain
As Spanish government bond yields began to soar in early April, the government announced on April 9th an additional €10bn in spending cuts. This came just days after prime minister Mariano Rajoy announced €27bn in austerity measures and tax hikes in the 2012 budget. Markets weren’t at all impressed by the additional cuts and bond yields rose further, proving that the Spanish government is truly in a no-win austerity/recession spiral.

If the Spanish government does not announce further austerity measures, the markets think it is not serious about hitting its fiscal targets and shun Spanish sovereign debt. If the Spanish government does announce additional austerity measures, however, the markets fret that the swingeing cuts will push Spain further into recession and shun Spanish government debt. No matter what the Spanish government does, investors are spooked, and this is unlikely to change over the next year unless Spain shows signs of being on a path towards sustainable growth.

How likely is it Spain will show signs of a return to sustainable growth any time soon? Not very. Spain’s unemployment rate hit nearly 23% in the final quarter of 2011 (youth unemployment exceeded 50% for the first time in January). The latest purchasing manager’s index (PMI) for Spain for March showed the worst result in 11 months at 44.5 (a reading lower than 50 indicates a contraction compared with the previous month). Worryingly, there was a substantial reduction in new orders, an indication that Spain’s PMI score will continue to deteriorate in the future. The Spanish property market has not found a floor yet, and will continue to undermine the quality of household and bank balance sheets. The government is implementing aggressive austerity measures and structural reforms, both of which significantly undermine growth in the short-term. When Spain releases flash GDP figures for the first quarter of 2012 on April 30th, do not expect the result to calm the markets. Furthermore, worse than expected GDP figures are likely to significantly undermine Spain’s progress on hitting its budget deficit targets. There is very little chance Spain will manage to reduce its overall deficit to 5.3% of GDP this year or 3% of GDP in 2013.

Good news is also unlikely to come from the Spanish banking sector over the next year. Even if Spanish banks manage to meet the new Tier I core capital ratio requirements in mid-2012, the Spanish banking sector remains a black hole and a source of huge uncertainty for investors. As unemployment continues to rise and property prices continue to fall in Spain, mortgage defaults will crystallise. Spanish banks will undoubtedly require further recapitalization, but it is hard to guess the timing or magnitude.

EZ-Wide Developments Won’t Help
Developments outside of Spain could further cause investors to shun Spanish government debt. It is very unlikely that a EZ firewall will be finalised at the IMF spring meetings on April 20-22nd. EU leaders completed negotiations on the EFSF/ESM contribution to the firewall in early April. While they announced they had raised the ceiling of the EU bailout funds, much of the funding has already been earmarked and the overall lending ceiling has not actually been increased at all. G20 leaders have suggested they are only willing to contribute to an IMF-led EZ firewall if the EZ first demonstrates that it is willing to help itself. The EFSF/ESM fudge does not bode well for significant G20 contributions. With no firewall in place, the risk of a disorderly default in the EZ will rise significantly and with Spain in the spotlight of the EZ crisis, investors could rush to dump their Spanish sovereign holdings.

Bailout imminent?
If Spain is unable to regain market confidence, will it be pushed into a bailout programme? Not immediately, but this does seem inevitable. The good news as far as Spain is concerned is that the country has already pre-funded half of its debt rollovers for 2012. Even if Spain faces unsustainable borrowing costs, it will not actually run out of cash this year.

Furthermore, the ECB will not stand idly by while Spain is forced into a bailout programme. At the very least, the ECB will step up its Spanish bond purchases through the securities markets programme (SMP). While additional long-term refinancing operations (LTROs) are unlikely so soon after the three-year LTROs were offered, the ECB may take further steps to prop up the ailing Spanish banking system.

While ECB intervention could buy some more time for Spain in the short-term, it is extremely unlikely to fundamentally change Spain’s fiscal or economic trajectories. In the absence of economic growth, Spain will eventually be forced to request official financing, potentially as early as next year.

For insight on some of Spain’s fundamentals vs Italy’s, see Spain vs. Italy: Who Will Need Rescuing First?

17 Responses to Why Spain Won’t Regain Market Confidence

  1. Pingback: Sunday links: willful disbelief | Abnormal Returns

  2. Samuel Nightingale says:

    It looks obvious now that the western country’s economic model based on Keynes has failed.The most obvious oversight comes in not recognising that there is now, and likely to remain so,a growing large portion of every country who are unemployed or elderly. The crux of the issue being that there is an inadequate amount of revenue available to each of their respective tax revenue. The only solution applied being the issue of ever increasing amounts of debt and crippling austerity in the form of grevious cuts. Would it not be a better solution if special accounts were created in each country specifically targeting the costs to the economy which the uneconomic element represents. Inflation could then be dealt with in the usual manner.

    • Dr Rajeshwar Nath says:

      The complacency concerning the European nations is also one of the leading issue of the world. They are satisfied with the level of state of art they have and are too much depending upon the fruits of work carried in the past. The Greece crisis was fall back of this perception. THE govt was satisfied with the state of art technology and did not go for any changes in corporate sector AS A Result could not face the international competition and found themselves in trouble. In most of the European countries earnings from the past investment continues to be one of the big source of monetary resources.as corroborated by input output analysis which is almost constant for quite some period

  3. Pingback: 15th April 2012: The Spanish Imposition And The Old Economic Growth vs Austerity Tradeoff « The International Perspective

  4. Pingback: 15th April 2012: The Spanish Imposition And The Old Economic Growth vs Austerity Tradeoff « Market Nightshift

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  7. Pingback: FT Alphaville » Further reading

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  9. Tom Shillock says:

    It seems to me that a significant part of the problem has to do with trade imbalances that have emerged over the past two decades, internally for EU as well as globally. Part of the solution is to restructure trade. This is in part a political solution or a collection of political solutions in the good sense. But nowadays the concept of “political solution” or “politics” means avoiding painful solutions and pretending to solve them until those who are responsible have got theirs and are out of office, public or corporate.

  10. Dario says:

    Way before Italy or Spain would need a bailout program, ECB would be forced to change monetary policy, printing money and allowing inflation to raise. A change who propbably will happen anyway if left will win eletcions and wie’ll get rid of Merkel.
    In conclusion, neither Spain nor Italy will need any bailout. What do we bet?

  11. Mark Allan says:

    There will come a day and not too far away either,that this situation will explode.
    The powers that be have done little to solve this crisis or even attempt to get to grips with it short of endless summits and statements as worthless as the paper they’re written on.
    With pernicious levels of austerity measures being imposed across Europe causing untold personal distress to people who are totally innocent victims of this crisis A situation is being created where people will no longer be able to or want to, live like third world citizens.
    Social unrest is bound to follow people will have had enough of seeing their lives drastically altered for the worse while the real instigators of this mess jet off on their vacations,change their Aston Martins and salt away their ill gotten “bonuses”

  12. PatrickA says:

    There has been more bad news for the Spanish banking sector today Megan.

    From the economist Shaun Richards blog.

    “Spain’s banks are reporting more bad debts

    The latest data from the Bank of Spain tells us that loans which it calls “doubtful” have risen to 143.8 billion Euros to 8.15% of Spanish banks loan books. This is a rise of 0.24% between January and February.

    Those who have followed the debate on the Spanish housing sector will feel that this is a consequence of the way that Spain’s banks have carried housing debt in particular on their books rather than dealing with it. As time goes by more and more of this debt will have to be included as “doubtful” particularly as the outlook remains poor for her housing market. We are seeing the “kicking the can” into the future fail yet again as the can lands in a future which is no better and in fact in some respects worse.”

    So if you are right and the ECB will step in it may need to do so soon..

  13. Pingback: How much more pain in Spain? – Super Bull Investor - Intelligence for the Successful Speculator

  14. Samuel Nightingale says:

    The only solution to the debt crisis that I can see is Monetary Reform breaking the stranglehold of usury banks and Governments to create value, or at least for the Fed, the ECB and other central bankers to realise the ultimate collapse of our financial system and to create value themselves alongside or instead of usury.

  15. Pingback: “Un rescate a España parece inevitable” | Lengua Origen

  16. Pingback: 28th May 2012: Squeaky Bum Time For Spain « Market Nightshift

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