The Spanish economy, Spanish debt, Spanish banks and further potential austerity measures! Part 2
While public sector debt (not the deficit) in Spain is actually relatively low as a percentage of GDP versus other countries such as Italy, Ireland, Greece and Portugal, Spain’s public sector deficit for 2010 will be around 11.3%. So, the Spanish government has announced several austerity measures to reduce this to 6% in 2011.
Unfortunately, many observers doubt Spain’s planned budget deficit reduction is achievable, not only because some of the austerity measures are yet to be implemented – but also because most of the regional governments, who account for at least 2.4% of the deficit, are not undertaking sufficient austerity measures.
In fact, Bank of Spain Governor Miguel Angel Fernandez Ordonez, recently told a Spanish parliamentary committee that: “Recent budget data point to the achievement of objectives for 2010, at least for the central government…. but (as far as the regional governments go) my impression is that the measures [they've announced] are far from sufficient
Analistos Financieros, a Madrid-based consultancy, has calculated that the refinancing requirements of Spain’s central and regional governments, along with the Spanish banks, will be of the order of €253bn in 2011 – of which €72bn falls in the first quarter. At the same time, new monies required in 2011 will be more than €60bn!
So, in total, Spain, one way or the other, will need access to over €300bn of financing in 2011. Add this to what other Eurozone countries need to borrow and refinance and you could make a good case for indigestion, regardless of the economic outlook for Spain and the Eurozone.
Nevertheless, much has been made of the fact that the Spanish banking sector, aside from a few cajas, passed the (flawed – witness Ireland) EU stress tests.
Unfortunately, the stress tests did not look properly at how Spanish banks account for their growing property portfolios. Most Spanish banks have an increasing number of repossessed properties on their books at unrealistic valuations and have been reluctant to write them down to their true market value. The Bank of Spain is gently forcing them to do this but I stress gently – slowly, slowly so as not to scare the market or contradict the message to the markets that Spanish banks are the best regulated and capitalised in the developed world.
Aside from repossessed properties in Spain, the Spanish banks’ outstanding loans to domestic Spanish property developers are around €350bn. With over one million unsold new properties in Spain it is expected that 61% of developers will default on their loans and that losses on loans to these developers could reach 75%. At the same time, domestic residential mortgages total €700bn and loans to construction companies total €120bn.
The total of the above three loan categories, i.e. excluding other consumer debt or loans to companies not involved in property exceed Spanish GDP and, according to Evolution Securities, losses on these loans alone could amount to at least €120bn! In fact, Spanish lenders have a total of €181bn in ‘troubled’ construction and real estate loans, the Bank of Spain said last month – although it is unclear if this includes consumer mortgages.
Given the current parlous state of the Spanish economy and Spanish property sector, I believe estimates of losses of €120bn to be conservative. In any event, losses of this magnitude would amount to more than 6x the annual profits of the banking sector. Bang goes their Basle III capital ratios!
In addition, private sector domestic debt, both corporate and consumer, is very high – thanks largely to the cheap and easy money arising from Spain joining the Euro zone and the resultant economic boom. With high unemployment and lack of economic growth one can assume that non-Spanish property related bad debt levels will continue to rise.
In fact, in its report “Banking System Outlook for Spain” published today (13 December), the ratings agency Moody’s estimates that Spanish bank’s losses could reach €176bn and that they will need at least €17bn of new capital. Meanwhile, profitability will remain under pressure and access to funding in the wholesale markets will remain difficult
In short, there are lots of skeletons in the Spanish banks’ cupboards!
So what is the answer to the question: is Spain’s economy ‘fit for purpose’ and can Spain avoid Ireland’s fate?
Well, in my opinion, Spain can avoid the fate of Ireland – but only if:
- the current austerity measures have the desired impact in reducing the deficit to 6%;
- the Spanish government makes further structural changes, for example the labour market and pension system reforms that the IMF, OECD, ECB et al have been asking for for a long time;
- measures are taken to reduce the financial independence of the regional governments;
- the ECB maintains its liquidity support mechanism for Spanish banks; and
- the ECB continues to buy Spanish government bonds.
And what are the chances of all these things happening in 2011? Probably less than 50%.
What I do think will happen is that further austerity measures and labour market reforms will be announced as and when Prime Minister Zapatero is forced to do so by the EU and/or market conditions (witness the recent announcement of the five year Integral Industrial Plan). Meanwhile, the ECB will continue to try and pre-empt a “run” on Spain and Spanish banks for as long as Germany is prepared to let it buy Spanish bonds.
However, the latter is in doubt, not only because of the constitutional challenge currently underway in Germany but also because of its insistence that from 2013 private investors should share some of the losses. This will discourage investors from buying Spanish (or any other peripheral eurozone country’s) bonds – hence putting further pressure on its ability to finance itself in the international markets.
It is worth noting that it was recently estimated that a 30% haircut on Spanish assets would cost UK, French and German banks €360bn. So, maybe Germany and the richer northern European countries will decide that this is unacceptable and allow the ECB to continue its underwriting/guarantor role. But I personally doubt it and think Spain, like Ireland, will be forced to turn to the ECFS/IMF fund. What that means for the euro is anyone’s guess – but I think the eurozone will split into a dual currency area.
Whatever happens, Spain has a long, hard road ahead, if it does not wish to remain in the second division economically with its over reliance on tourism and products which require manual or semi-skilled workers. It is true that the Spanish government is belatedly (and mainly because of external “pressures”) recognising the need for reforms – but, given the level of Spanish debt, whether these will work and be enough to prevent the meltdown of the Spanish economy remains to be seen.
Robert Tenison is an Anglo-Spaniard with over 30 years experience of doing business in Spain across a number of sectors. He has been living in Spain for the last 9 years and is the author of the novel Deadly Secrets (www.deadlysecrets.es), a story based in southern Spain about corruption, bribery and murder related to the urban planning process.