At the start of the month we highlighted the significant risks still in play in the Spanish banking sector and some of the wider policy issues in Spain. Echoing the conclusions in our briefing, over the past few weeks the calls for Spain to address these issues have grown louder while markets have grown increasingly jittery.
However, the pressure has noticeably picked up this week. The obvious example is last night’s decision by S&P to downgrade Spain to BBB+. This hasn’t had a huge impact on the markets, given that it was mostly expected and priced in, but the reasons behind the downgrade are nonetheless interesting and align with some similar points which we highlighted in our briefing:
- The on-going problems in the banking sector mean that a new injection of public money may well be needed at some point – which would significantly worsen Spanish debt sustainability and the ability of the government to meet deficit targetsS&P also went on to criticise the wider handling of the crisis at the eurozone level and the continued failure of eurozone leaders to address the true cause of the crisis (something which we’ve mentioned countless times throughout the crisis).
- The continuing growth challenges and competitiveness problems in Spain
- Although encouraging the structural reforms will take some time before they boost economic growth
- In the short term these structural reforms could actually increase unemployment (supported by today’s figures which show unemployment increase by 1.5% over the past three months)
On top of this move, the IMF also warned earlier this week that some of the smaller Spanish banks could need public money to boost their capital ratios and/or provisions against losses on exposure to the bust real estate and construction sectors. In our report we suggested that, given deteriorating economic conditions and falling house prices, the banking sector as a whole may need to double its provisions against souring loans. Goldman Sachs recently made a similar estimate, suggesting that a further €58bn may be needed on top of the current provisions of €54bn.
If this does happen, the question remains over whether it will be done with Spanish or European funds. Despite the clear limits on the amounts available to the Spanish government the stigma attached to asking for even a precautionary loan from the EFSF/ESM will make it a last resort. Not to mention the fact that, since it has to go through the state, any loan would increase the debt levels further.
Separately, in a move that doesn't inspire confidence the Spanish Foreign Minister Jose Manuel Garcia-Margallo today warned that the country faced a crisis of “massive proportions” and that “if it goes badly for us, it’ll go badly for others too”. Even worse, in a warning to Germany, he compared the eurozone to the Titanic, stating that when it went down the 1st class passengers went down with it before issuing the usual rallying cry for more growth.
Despite increasing concerns a bailout for Spain is, as we have said before, not yet a foregone conclusion. But the government needs to begin making headway convincing the market of its commitment to cleaning up the banking sector and promoting growth, but obviously both are easier said than done. With election season seemingly upon us in Europe it could be a long few months in Spain which could make or break the eurozone.