Treasury Today Country Profiles in association with Citi

The pain in Spain

The storm clouds are gathering in the Eurozone again. This time Spain finds itself having to batten down the hatches. Its problems lie as much with the prospect of sluggish economic growth as they do with the onerous levels of national and private debt with which the country is laden. The markets worry that domestic demand is weak and the austerity measures introduced by the government have done little to lift the mood among consumers.

“I think that markets are increasingly worried about the impact of these huge austerity measures on growth. Some experts have calculated that for every €10 billion of spending cuts, Spanish GDP loses between 0.6% and 0.8%,” says a Finance & Treasury Manager based in Spain.

Prime Minister Mariano Rajoy unsettled the debt markets last month when he signalled that the country’s budget deficit would be slashed less quickly than the government had originally planned. Since then, yields on ten year notes have started to slowly edge beyond the 6% mark – an unsustainable interest rate and one which is likely to trigger an ECB buying spree if they push toward the 6.25 – 6.50% mark.

Bond yields had been brought to heel when the Spanish banks tapped the ECB for liquidity when it was put on offer during LTRO I and II, but the current crisis of confidence that is making itself felt on the markets emanates from the perceived lack of solvency of the country’s government and some of its banks, not the liquidity of its financial institutions.

Daily – Spain 10Y Bond

“The markets have become sceptical over the ability of the Spanish government to reduce its budget deficit from 8.5% of GDP in 2011 to 5.3% this year. Even if these cuts are successful, Spain’s national debt is projected to rise 11% this year to almost 80% of GDP. Austerity comes against the backdrop of an unemployment rate of 23% – youth unemployment is close to 50% – and a stressed property market.”

The head of the Spanish central bank has warned that the country’s banks may need more capital if the recession deepens. Political leaders have been quick to deny that Spain will need a bailout and the ECB has hinted that it could re-launch its bond buying programme to cool Spanish bond markets,” notes RBS’s Chief Economist in his weekly briefing.

Notwithstanding the storm brewing on the Iberian debt markets, the Spanish treasury managed to sell €3.18 billion of T-bills on Tuesday, compared with a maximum target of €3 billion the Treasury set for the sale. The average 12-month yield was 2.623 per cent, compared with 1.418 per cent at last month’s auction. The Treasury also sold 18-month T-bills at 3.11 per cent, compared with 1.71 per cent last month. Demand for the 12 month notes was almost 3 times oversubscribed, compared with 2.14 times last month. At the same auction, demand for the longer maturity notes rose to 3.77 times from 2.93. The success of the short-term debt auction meant that benchmark yields on 10-year government bonds fell below the 6% mark.

However, today promises to be the real litmus test for the economy. With auctions of two and ten year debt in the offing, if interest rates continue to sit stubbornly above 6%, the ECB bond buying machine is likely to be kicked into action again.

“In Spain, the real problem lies in the external debt of the private sector – banks, companies, etc. The situation of the banking sector is expected to get worse with the recession and increasing unemployment. That has tied their destiny to that of the public finances through their recent Spanish debt purchases,” explains the finance and treasury manager. “These main sources of concern – lack of stimulus, private debt and the banks’ situation – have, in my opinion, taken the headlines by storm because of the significant slippage in the country’s 2011 deficit and because the new government preferred to postpone the 2012 budget until after the elections in Andalusia.”