Spain’s toxic mix is bubbling and may overspill in September. The euro-zone’s fourth largest economy is feeling the heat from all directions: banks, regions, bond markets and also rating agencies.
Is it just darkest before dawn? Spain took its time (one month and counting) with asking for aid from its peers – a move that will include new austerity as well as ECB help. The country can wait for the German court’s ruling, but not much further.
Spain’s fronts:
- Bankia: The troubled bank reported another loss and the government announced another capital injection, without waiting for European funds. This weighs on the government’s budget, which already surpassed the projected 2012 budget. The link between sovereigns and banks is just getting stronger instead of being broken. One anecdote is that Cristinao Ronaldo could be transferred to the ECB. Other banks could ask for money as well. Spanish banks suffered from the bust that followed the real estate boom. With house prices continuing to fall, the deleveraging process still has a long way to go. An unorthodox solution is forgiving mortgages under a certain rate, as Iceland did, but this isn’t on anybody’s agenda at the moment. The capital flight from Spain continues at full speed.
- Regions: The list of regions asking for help is growing. Spain’s most populous region, Andalusia, was the most recent to ask for aid from the government. All regions are shut out of money markets. Andalusia joins Murcia, Valencia and Catalonia, which is a more complex case.
- Catalan discontent: Catalonia is a rich region that feels that it is mistreated both economically and politically. Many Catalans feel that they are subsidizing other regions for many years and feel that asking for help from the central government is absurd. The recent crisis raised separatist aspirations, as seen in various opinion polls. Various anti-crisis and pro-Catalan demonstrations are being held. The demonstrations will reach a peak on September 11th, Catalonia’s national day. Catalan nationalism is triggering some counter reaction. A Spanish colonel said that Catalan independence will come over his “dead body”. Spain’s democracy is still young and memories of the dictatorship and the civil war are still present.
- Internal discontent: The government already announced austerity measures, which include a raise of the VAT. In endless appearances, politicians explained why raising the VAT is bad, until they took the decision to raise it. The government’s political capital is suffering a serious deficit, only 10 months after winning a landslide victory. The higher VAT is a reaction to weak tax collection: this fell by 3.5% instead of a projected 4.3% rise. The slow response to summer fires in the Canary Islands was also partially blamed on government cuts.
- Rating: On this background, Spain is paying high prices in the bond markets. Draghi’s announcement at the beginning of August helped in lowering yields, but this honeymoon is over. During September, Moody’s is expected to downgrade Spain’s credit rating to junk status (after warning in June), and this will send more funds away from the country.
All in all, the picture is quite depressing. The path to lowering yields in the secondary market is via the ECB. For the ECB to buy bonds, a Spanish aid request is needed. PM Mariano Rajoy opened the door to asking for aid, but didn’t walk through this door. He will probably do that in September.
While the ECB has unlimited buying power, conditions apply. After making a U-turn on VAT, Rajoy will find it hard to make a U-turn regarding asking for aid. In addition, new austerity will be hard to sell in the current situation.
Rajoy’s moves haven’t been that smart so far, and he has a tough job tiptoeing between getting help but keeping his country’s economy afloat. September is a critical month for that.
But let’s end the chapter about Spain with two positive numbers:
- Spanish tourism breaks records: 7.7 million foreigners in July, up 4.4% YoY.
- Spanish labor costs fell 2% while exports are growing – a weaker euro is helping Spain. This is a small fruit of austerity, drowning in a toxic sea.
This is an adapted version of this topic from the forex monthly outlook. You can download the full report by joining the mailing list below.