Nearly five years into the European debt crisis, the European Union has finally begun addressing the financial challenge it faces in both word and deed. This year, the EU committed to forming a banking union and formally launched the European Stability Mechanism (ESM) to provide financial assistance to euro-zone member countries. In September, European Central Bank (ECB) President Mario Draghi provided a rhetorical boost when he vowed to do “whatever it takes” to save the euro. However, despite signs that Europe is moving to dig itself out of its economic hole, there remains a great deal of concern that a possible Spanish default could overwhelm efforts by the ECB and ESM to get Europe back on track. While small countries like Greece, Portugal, and Ireland have managed to escape full-blown default thanks to German-financed bailouts, the size of the Spanish economy means that Spain is an altogether different animal.
At the heart of the Spanish problem is the massive debt created during Spain’s decade-long real estate boom. Cheap loans helped fuel the boom, but when the market went bust, both families and banks found themselves in deep trouble. A massive restructuring of the Spanish banking sector, including government-led consolidations and, in some cases, outright nationalization, has not restored confidence in the country. As a result, Spain is reportedly ready to turn to the EU to bail out its ailing banks. According to Reuters, the Spanish government is expected to prop up lenders by tapping EUR60 billion ($77 billion) from a EUR100 billion ($128 billion) European Union credit line.
Public and Private Debt
The country’s sizable public debt is also a major worry. Although the Spanish government has implemented a string of austerity measures, Madrid still has not met its budget targets. In a recent note entitled Spain: More Needs to be Done, Credit Suisse analyst Andrew Garthwaite said he expected government debt to continue growing, peaking at 106% of GDP by 2014, up from about 78% this year.
The double whammy of high public and private debt has resulted in a vicious cycle. The country needs to boost domestic consumption to help its economy but severe austerity measures, designed to fight government debt, have resulted in 25% unemployment and left Spanish consumers feeling squeezed. In turn, the sluggish economy means government revenues are down, making reduction of public debt ever more difficult.
Ironically, it is concern over a potential Spanish default that helped galvanize the EU into taking more decisive action to deal with the crisis. There is hope that the recent moves to establish the ESM could help stabilize Spain. But Joe Prendergast, head of fixed income and credit research at Credit Suisse’s private banking unit, said in a recent Credit Suisse video bulletin entitled Euro Crisis: Monitoring Spain’s Pain, that the ESM is not large enough to single-handedly bail out the country. However, he believes the ECB’s OMT bond buying program has the power to address the Spanish problem by adjusting interest rates.
Will Catalonia Split?
As the waiting game continues over whether Spain will turn to the ECB to help it overcome its debt crisis, the country’s deteriorating economy is impacting the political arena. The pro-independence movement is building momentum in Catalonia, where the regional elections on Nov. 25 could become an unofficial referendum on the independence of one of Spain’s richest provinces. According to a recent poll, some 53% of Catalans have said they would vote in favor of independence if given the opportunity, while 35% would vote against it. With an annual economic output of $260 billion, the loss of Catalonia could have dire consequences for the Spanish economy.
Despite the strong sentiments in Catalonia, Credit Suisse’s Prendergast doesn’t anticipate a split of the Spanish kingdom, pointing out that separatist feelings are not new to Spain. “It’s an issue investors certainly should be monitoring and it’s likely we will see a path towards greater independence and autonomy for Catalonia as we go through time, but I doubt we have any immediate risks of secession or departure from Spain,” he said in the Credit Suisse bulletin.
Still, the real political fallout from the Spanish economic situation may come, not in the domestic sphere, but at the EU level. Now that the EU has set up institutions to help member states reeling from the continent-wide debt crisis and the ECB has started talking tough, we may get to see just how far the political union is willing to go to rescue one of its larger national economies.
Credit Suisse’s Joe Prendergast speaks about Spain’s debt crisis and how it could impact the upcoming regional elections in Catalonia, the country’s richest province.
Photo: Pedro Rufo / Shutterstock.com