Spain suffered its worst drubbing in the bond market since the inception of the euro, raising the spectre of an enormously expensive debt restructuring and bailout for the fourth-largest country in the euro zone.
Sunday’s Greek election results signalled support for the euro in the economically ravaged country, but failed to ease deepening worries about much larger Spain’s own deteriorating finances, ailing banks and darkening economic prospects.
The yield on the benchmark 10-year government of Spain bond zoomed nearly a third of a percentage point to close above 7 per cent for the first time since the country became a charter member of the monetary union in 1999.
Spain’s central bank provided extra fuel for the bond assault when it reported that troubled loans held by Spanish banks climbed close to a record 8.7 per cent in April – or €152.74-billion ($197-billion). Non-performing loans across the euro zone total just under 7 per cent, as a region-wide slump takes its toll. By comparison, such loans at Canadian banks are less than 1 per cent.
Battered Italy also saw bond yields rise to 6.08 per cent, and equity markets in both countries took a beating, underscoring a prevailing lack of confidence in the ability of European leaders, many of whom remain focused on austerity, to resolve the crisis.
“While Greek euro exit fears have … eased, this outcome does little to alleviate the weak fundamentals that currently weigh on Spain and Italy,” Michala Marcussen, head of global economics with Société Générale, said in a note. “To ease these fears … additional risk-sharing at the euro-area level is required.”
Greece, Portugal and Ireland were all forced to seek bailouts when their own borrowing costs reached the 7-per-cent mark. Like them, Spain and its banks had tapped the capital markets aggressively to take advantage of a strong euro and low interest rates in the early 2000s. The Spanish 10-year rate reached a record low of 3 per cent in September, 2005.
The profligate borrowing left a mountain of debt and soaring budget deficits when the Spanish property bubble exploded during the financial meltdown of 2008. But unlike that unfortunate troika, vastly larger Spain is regarded by many analysts as simply too big for Europe to rescue on its own.
Spain has to refinance about €200-billion in sovereign debt in the next three years and its banks potentially need another €250-billion in debt refinancing, said Michael Yhip, president of Toronto-based Garrison Hill Capital Management. “Spain will need a full-blown bailout.”
The government has warned that it cannot cope with sky-high interest rates, which have been driven in part by fears of a restructuring that would force private creditors to take large haircuts. Finance Minister Cristobal Montoro called on the European Central Bank to resume its purchases of Spanish bonds to drive rates down. Mr. Montoro warned earlier this month that he was running short of financing options, as “the door to the markets is not open for Spain.” But the ECB has said it has no plans to resume its intervention in the secondary market.
Madrid is proceeding with plans to sell between €2-billion and €3-billion of 12-month and 18-month treasury bills Tuesday and up to €2-billion worth of longer-term bonds Thursday. Like other euro zone countries facing unreceptive markets, Spain has largely focused on easier-to-sell short-term debt while reducing the amount of longer-term offerings. But that is a costly and inefficient way to refinance.
The European Union has agreed to a bank bailout of as much as €100-billion for Spain. But analysts say it may not be enough to recapitalize the crumbling sector, especially as the economy continues to weaken and loan losses mount. Another concern is that the bailout merely adds to the government’s growing tab, since it will be responsible for paying back the money.
“Today has been a difficult day,” Spanish Economy Minister Luis de Guindos told reporters at the G20 meeting in Los Cabos, Mexico, insisting that the country remains solvent and its austerity program is working. “The current situation of market penalization doesn’t reflect the efforts and the potential of the Spanish economy.”