New dangers lurk for rudderless Spain

2012-06-21 13:30

Madrid - Spain seems trapped on a conveyor belt carrying it towards a furnace - an international rescue of the eurozone’s fourth-biggest economy.

Bad commercial loans, economic decline and sliding real estate prices are all aggravating problems at Spain’s over-extended banks, which lent too much too freely during a credit-fuelled property boom that lasted almost a decade.

Madrid’s eurozone partners are making available up to €100bn to clean up the banks and, they hope, shield Spain from a debt crisis that has engulfed Greece, Ireland and Portugal and now threatens the single currency project itself.

But grave risks remain as the economy succumbs to a cycle of budget cuts destroying economic growth, leading to more cuts.

Many in the bond market don’t believe Spain can save itself - more evidence of that came on Thursday when Madrid’s five-year borrowing costs hit a 15-year high above 6%.

“Spain is getting too close to a point of no return when it comes to public debt,” said Alejandro Ruyra financial analyst with Kepler Research in Madrid.

Signs of the spending spree that began when Spain joined the euro in 1999 are everywhere - empty apartment blocks, unused airports, grandiose cultural centres and highways to nowhere.

The house of cards collapsed in 2007-2008 leaving banks with €300bn - equivalent to almost one-third of annual economic output - of exposure to the property sector.

The banks, and Spain’s indebted regions, have been economists’ main focus in trying to fix the Spanish problem.

The International Monetary Fund’s (IMF's) worst-case scenario forecasts Spanish housing prices falling 20% this year - they have already fallen as much as 30% since 2007. 

A Reuters poll assuming no worsening in economic conditions - an optimistic scenario - sees prices dropping by 10%.

The IMF says Spain’s financial system would need at least €40bn to weather a serious economic storm and recommends a figure far in excess of that.

In theory, the bank bailout agreed earlier this month should banish doubts over whether lenders can handle the fallout from economic recession.

Added to that, the property market is beginning to move finally as sellers start to cut the asking price for homes that on average are taking in excess of a year to sell.

But beyond the property market, the construction firms and other businesses most exposed to the price crash, there are other dangers.

A detailed independent audit of the banks by four major global accounting firms - due by September - may show companies from other business sectors have also been pushed to the brink of default.

Banks are already seeing rising mortgage defaults and bad loans in non-property sectors.

Time is also of the essence.

One banker who says the audit should find the banking system mostly sound still doubts it will come on time.

“What I’m not sure is whether it will be enough to recover market confidence, that it is not going to make things worse,” he said, speaking on condition of anonymity because of the business sensitivity.

Centre-right Prime Minister Mariano Rajoy, who pledged to restore investor confidence in Spain only to see the crisis deepen during six months in office, is pressing for outside help rather than enacting convincing new measures at home.

Investors have steadily lost trust in Spain.

Moody’s credit rating agency downgraded Spanish sovereign bonds to just one notch above junk level, which means only investors with a high tolerance for risk will touch them. Tracking the bond market has become a national obsession.

Public outrage is growing that every euro cut from spending on schools and hospital is going to pay higher financing costs on the national debt or to rescue banks.

Unemployment is the highest in the European Union - 24.4%. Banks have gone from lending too much to not lending at all, and families and companies nervous about the future have stopped buying.

Economic activity risks grinding to a halt.

New leader disappoints

After taking office in December Rajoy thought he would forge an alliance with Germany’s Angela Merkel, a fellow conservative, and quickly win back the confidence of financial markets with belt-tightening measures.

With his People’s Party’s enjoying an absolute majority in parliament he easily passed an austere budget that slashed spending on international aid and job training schemes, and introduced laws to make the economy more competitive by reducing labour unions’ pay bargaining power, for example.

He also cracked down on Spain’s 17 autonomous regions, which were meeting bond payments by delaying pay cheques for health workers and street sweepers.

But Rajoy was undermined by his own limited experience on the international stage. He tried too fast to win more leeway on deficit cutting from European partners and soon got frustrated with Merkel’s perceived inflexibility.

His European strategy has now become a major risk for Spain.

Rajoy has clung to the argument that he has done enough and it is now up to the European Central Bank (ECB) or the European bailout mechanisms to step in with emergency action to bolster Spanish debt prices while his reforms take effect.

“How far does Europe have to go to the edge before the ECB steps in?” asked one high-level Spanish official.

This game of chicken - basically a Spanish threat to take the euro currency to the brink of disaster unless it gets aid with minimal strings attached - will be hard to sustain.

European leaders are pushing Rajoy to raise sales tax, further cut public sector wages and speed up plans to raise the retirement age.

“Rajoy has lost too much credibility over the last few months to just appeal for the ECB to intervene and for Europe to continue to support him.

"He’s unrealistic if he thinks Europe is going to help him without getting something in exchange and they’ve been unimpressed recently by what he’s done here,” said David Bach, political analyst at IE business school in Madrid.