Spain has recently traded places with Italy to become the country on which may depend the future of Europe. Bond yields are on the rise while the successful sale of Spanish debt securities was the big event of last week. This shows how much anxiety there is about Spain’s prospects. The problems facing the Spanish economy are linked above all to the enduring slump in the property market which directly affects both the banking sector as well as the real economy as a whole, including the labour market and tax revenue.
In 2012 Spain is in a recession estimated at 2 to 3%. The austerity measures and taxes have reduced people’s purchasing power in a short time. But above all, the Spanish economy must achieve balance – mainly on the property market. Only from that moment will growth be possible. The figures show that this has not happened yet.
European politicians were lulled into passivity when the ECB flooded the entire european banking market with ample cash with which to buy up bond issues. But as I mentioned before, throwing liquidity at Europe’s problems is not the way to solve them. The temporary respite also pacified the financial markets which for a certain time started to proclaim the end of the crisis in Europe. This was short lived however and we are again witnessing nervousness which comes above all from the risk that the situation will get out of control. It’s common to read estimates of the potential restructuring of Spanish debt. Fortunately the debt bogeyman is no longer as terrifying as it was as restructuring was achieved in a controlled and efficient way in the case of Greece therefore it will be possible to do the same for Spain. I think however that while in the case of Greece debt restructuring was on the cards right from the start, the case for Spain is not as clearcut. Regarding the scale of public debt, Spain is not doing that much worse than the rest of the Union with a debt to GDP figure of 80%. Things are worse regarding private debt which continues to grow and more seriously, it is impossible to accurately estimate the size of the private debt burden. Together with further falls on the property market it may be that companies will get into an even worse mess as will the banks financing them. This will in effect increase the scale of indebtedness. And this situation is not likely to go away for at least the rest of this year. This leads to uncertainty on the financial markets and fears of a really bleak picture. It will be a long time before we can say that the worst is behind us.
As soon as a country finds itself grappling with particularly difficult issues, this immediately conjures up scenes of eurozone disintegration. I would however take such doom mongering with a pinch of salt although fear itself fuels uncertainty and worsens the mood. Over the coming months we will see the mood barometer fluctuating – it is important that politicians not be deceived by this as was the new Spanish premier Rajoy.
Liquidity from the ECB mitigated the acuteness of the situation and encouraged the postponement of crucial reforms while for the southern countries there is no other path than the difficult and unpopular one. The market has got to find balance – important in order to avoid the domino effect which would lead to the collapse of the banking system and of the whole economy. This seems to shore up the necessity of following the USA approach of capitalising the banks to fend of the worst case scenario. In the real economy not just savings but supply side reforms of the labour market will be crucial in order to increase the flexibility of the economy.
Beyond Spain, Portugal is still in dire straits and debt restructuring will almost certainly take place. Italy has been experiencing problems where premier Monti’s government is experiencing serious difficulties in its attempts to reform the labour market. These dark clouds which are again hovering over Europe should help reformers make their case because some people thought that what has been done so far is enough. Unfortunately it will be a very long stretch before we have put the debt crisis and lost of competitiveness behind us. Something which we would do well not to forget.
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