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Tuesday, April 03, 2012

Not so bullish now? The short term prospects for Spain inside the eurozone

In a new briefing, Open Europe assesses the state of the Spanish economy in light of recent budget proposals, announced by the Spanish government in full today. Spain is not the “next Greece” - it remains a serious and diverse economy, with relatively good administration and infrastructure. However, the increasing exposure of its banks to potentially toxic loans, the difficulty in curbing Spanish regions' spending and the risk of reforms not taking effect quickly enough, all raise serious questions as to whether the Spanish economy will make it through without some sort of external help.

Key Points
• Given its size, the fate of the Spanish economy will also largely decide the fate of the euro. €80bn of €396bn (1/5) in loans that Spanish banks have made to the bust construction and real estate sectors are considered ‘doubtful’ and potentially toxic, meaning at serious risk of default, with the banks only holding €50bn in reserves to cover potential losses. Already dropping, house prices could potentially fall another 35%, meaning that Spanish banks will almost certainly face hefty losses as more households default on their mortgages.
• In such a scenario, the Spanish state is unlikely to be able to afford to recapitalise its banks, meaning that the eurozone’s permanent bailout fund (the ESM) would have to step in, shifting the cost to eurozone taxpayers.
• As domestic banks are currently the main buyers of Spanish government debt, this could also lead to major funding problems for Spain. The chances of a self-fulfilling bond run on Spanish debt would increase massively in this scenario, threatening to push the whole country into a full bailout.
• Containing spending in the Spanish regions is also key to Spain rebalancing its books. The level of unpaid debt on the balance sheets of local and regional governments has risen by €10bn (38%) since the start of the crisis (now topping €36bn). This will likely be paid off by the central government, increasing the country’s debt and deficit.
• Spain’s various reforms, particularly to the labour market, are welcome, but are themselves not enough to stop a bond run, as it will take time before they bite. The country’s long- term unemployment has now reached 9% of the economically active population, and youth unemployment reached 50.5% last month. This is threatening the long term productivity of the economy and whether Spanish society can sustain this level is unknown.
A Spanish bailout is far from a forgone conclusion, but more work needs to be done to avoid one. Open Europe recommends:
• Spanish banks double their provisions against souring loans and commit to thorough stress tests.
• Strengthen labour market reforms, particularly to relieve the welfare burden on state finances, including: end wage and pension indexation to inflation, reduce size and duration of benefits, limit collective bargaining, reduce redundancy costs and improve the business climate.
However, these reforms will only stand the test of time if they enjoy political buy-in across Spanish society and are seen as democratically legitimate, rather than being imposed from outside.

To read the report in full, please click here,

1 comment:

Rik said...

The banks should be reorganised first. This should have been done long ago. It is relatively cheap compared to rescuing a country the size of Spain.
Now the sector has next to the sov. debt problem and a potential huge exchange problem also a huge bad loan problem and the management problem is still not solved. Several of the de facto bankrupt cajas are ruled by local politicians and alike.
What is worse the LTRO made the sov. debt exposure even greater than it already was.

Banks at least several of them cannot double reserves/provisions for bad loans as they are already heavily in the red. They should have a recap first.

The labormarket reforms look simply barely having started. People should invest (and hire) in Spain and not in say Slovakia or Poland where labor is less than half the price. And remember they need 3-4,000,000 jobs to get unemployment to an acceptable level. You donot see them make 5% thereof (effectively the whole picture reduced the number of workers).

With this no of unemployed you will see no growth for several years. And it will be extremely difficult without cutting the welfarestate in half or so to run a balanced budget.

Looks like on a sure way to a rescue and subsequently an Euro exit. The people in Spain will not go for 1-2 decades of austerity and the rest of the EZ will very unlikely subsidise the massive Spanish welfarestate while they already should be cutting in their own.