Spain denies need for bailout as debt fears spread

Share

A disturbing pattern is emerging in the galloping euro zone debt crisis. A struggling country denies it needs a bailout. Investors don't believe it and drive up sovereign bond yields, making the bailout inevitable.

The no-bailout-yes-bailout reversal happened in Greece earlier this year. Two weeks ago, Ireland's hapless politicians forcibly denied a bailout was needed, then accepted one on Sunday. On Friday, it was Spain's turn to deny.

Spanish Prime Minister Jose Luis Rodriguez Zapatero told Barcelona broadcaster RAC1 that he is "absolutely" ruling out the need for a rescue package from the European Union and the International Monetary Fund and said speculators betting on plummeting Spanish bond prices might get burned. "I should warn those investors who are short-selling Spain that they are going to be wrong and will go against their own interests," he said.

Not to be outdone, Portugal issued a similar denial after media reports in Germany suggested that the European Central Bank and some countries in the euro zone - the 16 European Union countries that share the euro - were heaping pressure on Portugal to accept a bailout. European Commission President Jose Manuel Barroso, who is a former Portuguese prime minister, rejected the German reports as "absolutely false."

The Spanish and Portuguese offensives came after the bond yields of the two countries surged, thanks to fears that the euro zone debt crisis is accelerating. The yields on Spanish bonds have climbed more than 100 basis points (one percentage point) since the start of November, with half of that increase coming in the last week, in the wake of the Irish bond collapse. The yield on 10-year Spanish bonds went as high as 5.28 per cent on Friday, pushing the spread over benchmark German bonds to 264 basis points, the highest level since the euro was born 11 years ago.

Spanish yields fell slightly later in the day, when the Spanish government announced it would proceed with its remaining debt auctions this year, though they would be scaled back slightly because the state is well funded. Ireland, meanwhile, took a fresh blow when Standard & Poor's lowered the credit rating of Anglo Irish Bank six levels, to junk status. The ratings on other Irish banks suffered only one-notch drops.

The euro zone countries, both weak and strong, are finding it impossible to shield themselves from the debt contagion. Yields on Belgian bonds, considered one of the euro zone's safest sovereign investments, have been steadily rising and reached 3.68 per cent, more than a full point over German bonds. The cost of insuring Belgian bonds is climbing, even though the country has a fairly strong GDP growth rate (2.1 per cent in the third quarter) and a relatively low budget deficit. Italy's bond insurance costs have also been rising, though less sharply than Spain's.

Spain is doing everything in its power to avoid becoming the next bailout victim. If its efforts fail, the entire euro zone would be at risk because the Spanish economy is 70 per cent bigger than that of Greece, Ireland and Portugal combined. A bailout would strain the resources of the €750-billion ($1.01-trillion) euro-region bailout fund, which is dominated by the €440-billion European Financial Stability Facility.

On Wednesday, Axel Weber, president of the German central bank, said if the fund isn't big enough to reassure markets, "it will have to be increased," a statement that only raised fears that more bailouts were likely.

While Spain's 2010 budget deficit is high, at 9 per cent of gross domestic product, its national debt at about 53 per cent of GDP is fairly low by euro zone standards, giving it some flexibility. Some economists say that, on paper, Spain should not be a bailout victim because its deficit is coming down, thanks to austerity measures and tax hikes; exports are improving; and unemployment seems to be stabilizing, though it remains painfully high at about 20 per cent. Local banks, which were heavily exposed to the collapsed real estate sector, are being restructured, though economists say the effort should be accelerated.

In a recent note, Deutsche Bank economist Gilles Moec said, "We consider that [Spain's]fiscal consolidation is on track" and should not require fresh austerity measures, for fear that another round of brutal cutbacks would damage recovery prospects.

But Spain's successful deficit-reduction efforts may not be enough to fend off the bond sellers. Traders say Spain is particularly vulnerable to any whiff of default anxiety because it, unlike Ireland and Portugal, has a highly liquid bond market, which is attracting short sellers.

______

HOW SPAIN STACKS UP

Economic expansion in Spain lags the rest of Europe, where growth has been driven mainly by the strength of the German economy. In the third quarter of 2010 the Spanish economy was flat, although year-over-year growth showed a small gain of 0.2 per cent - the first uptick in seven quarters. Sharp cuts in civil service wages and the suspension of road and rail building projects, along with a rise in the value-added tax, haven't helped.

Unemployment: 20 per cent

Spain's unemployment rate is among the highest in Europe. The number of jobless has risen by almost a million per year since the real estate bubble burst in 2007. By comparison, Germany's jobless rate is less than 7 per cent, and the average for the European union is just under 10 per cent.

Inflation: 2.3 per cent

The rise of consumer prices in Spain has been moderate, although October's rate is up slightly from 2.1 per cent the month before, and is at its highest level in two years. Higher power prices and the jump in the VAT were the main culprits. One worry is that salaries are generally indexed, and the country can't afford to increase pay if inflation jumps higher.

Public debt: 53 per cent of GDP

Compared to many other parts of Europe, Spain's public debt is at reasonable levels. Both France and Germany are in the mid-70s, while the European Union average is 74.7 per cent. French and German banks have the highest exposure to Spain's debt, together holding about 60 per cent of its bonds. Still, the spread between German and Spanish bonds has been rising sharply lately, especially after the crisis in Ireland came to a head.

Richard Blackwell