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Monday, July 23, 2012

How long can Spain fund itself at these levels?

Once again the crisis came roaring back this weekend, with a terrible Spanish debt auction last week and rumours that a raft of Spanish regions will need aid from the central government (as we predicted here) sending Spanish 10 year borrowing costs skyrocketing to a record 7.55%.

The questions now turn to how long the central government can fund itself and its regions at these levels.

By all accounts Spain has done well to ‘pre-fund’ a large amount of its debt this year (meaning its already borrowed most of the money it needs to), while the average interest rate on its debt remains fairly low (around 4%) while the average maturity of its debt is around six and a half years – in all not a bad debt profile considering everything. However, around 10% is soon to be added to the debt to GDP ratio while the mounting costs of bailing out the Spanish regions will only exacerbate this. All the while growth continues to stall – the Bank of Spain announced this morning that the Spanish economy contracted by 0.4% in the second quarter of this year, to add to the 0.3% decrease in the first quarter.

Those of you that read our recent report on the Spanish bank bailout will know that we pre-emptively tackled this issue in detail, but just in case here’s a refresher from the report:
 …looking at the Spanish state’s funding needs over the next few years, even with the recapitalisation of the banks taken care of, it faces a huge level of debt refinancing. Up to mid-2015 Spain faces funding needs of €547.5bn, over half its GDP and a large majority of its debt.

Spanish debt maturing
The Spanish central government will need to rollover €209bn in bonds and €75bn in bills, equal to almost 30% of GDP and close to half of its official debt. This will become increasingly difficult if Spanish borrowing costs remain at elevated levels.

Spanish deficit 
From mid-2012 to mid-2015 Spain will have to finance a deficit worth €179bn – that is assuming it manages to stick to the IMF projections and its deficit cutting plans.

Unpaid bills 
Spain also faces large stocks of unpaid bills at all levels of government, totalling around €105bn. These are due to be wound down over the next year or two despite having been at elevated levels for some time. Ultimately these funds are mostly owed to domestic creditors meaning withholding the money for longer will be counterproductive for the Spanish economy. (In light of this weekend's  rumours its interesting to note that the recent boom in arrears came nearly exclusively from regional governments).

…the amount to be rolled over in the next year or two is still particularly large…This will further increase the pressure on the banks to load up on Spanish sovereign debt, with potentially huge consequences if this loop ever breaks down. If the problems in the banking sector are not resolved their ability to continue funding the state will at some point come under huge pressure, if this falls apart Spain may find itself without any willing creditors.


Rik said...

The amount of roll overs is not really important. If it would be tried to keep the yields say below 7% you have both the roll overs as well as the normal secundary market to deal with.
Basically you have to act as a buyer for everybody who wants to sell there. As the price of the bond is (substantially and) clearly higher than its value basically no normal market party will buy. Unless it would be more or less guaranteed that this will continue (but we havenot seen that yet in this crisis, a lot of big talk but everything highly conditional).

Basically what you need is both buying the roll overs (and new debt) plus a buyer for the secundary market. If not you will with say Spain end up in a situation in which you have existing bonds with 10+% yields while new issues are against say 6%. An unworkable situation.

It can work but you should be willing to let the secundary market go completely and you need an E-thing to buy the new issues. A normal bank can never defend against its shareholders that it accepts say 6% when somewhere else for the same thing they could get 10%.
This way you donot require to finance the roll over and the secundary market is not longer an issue. However Spain's banks will likely take a hit and a few others as well. And Spain would be an official bail out.

Preferably combined with with a PSI (especially extending the duration, to avoid roll overs). If you donot need to roll over only the new deficits have to be taken care of. And that is a much lower amount.

Anyway seen the present rescue-capacity this simply looks unavoidable. If Spain becomes an official candidate (probably a matter of weeks) the capacity is already hardly enough and Italy looks almost certain to follow.

Anonymous said...

You write: "...while the average interest rate on its debt remains fairly low (around 4%)..."

Please remember, when Greece waved the white flag and begged for a bailout their average coupon was only 4.4 percent. And while both Greece and Spain killed their banks before they asked for a bailout (by more or less forcing them to buy ridiculous amounnts of sovereign debt), the overall health of Greek banks was much better.

Rollo said...

You have missed the point. It cannot fund itself at all. All it can do is pile up the debt mountain, so that interest payments increase exponentionally. The bailout needs to be 4 Trillion Euros to work for the eurozone as a whole, or as a hole.