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Wednesday, April 4, 2012

Spain’s rapid descent into crisis raises spectre of troika bailout




Spain is setting records this year and none of them is making Spanish budget and finance officials smile.

The country’s unemployment rate has reached a new record and the government revealed Tuesday that its national debt will soar to a level not seen since 1990. The ratio of debt to gross domestic product will reach 79.8 per cent this year, up from 68.5 per cent in 2011, because of rising sovereign borrowing costs, the cost of the bank rescue fund, transfers to ailing regional governments and the contribution to the fresh Greek bailout.

While Spain’s new debt-to-GDP ratio is not outrageously high by euro zone standards – Italy’s is 120 per cent and Greece’s is 160 per cent – the rate of increase has been much faster than expected. Only a few weeks ago, some economists, including those at the International Monetary Fund, were predicting that Spain’s debt load would not reach 80 per cent of GDP until 2016 (the euro zone average is 90 per cent).

The relentlessly higher unemployment rate is almost certainly the byproduct of falling economic activity as national and regional governments cut back on spending and hike taxes to plug gaping budget deficits.

In March, a record 4.75 million Spaniards were unemployed, taking the jobless rate to 23.6 per cent, the highest in the 17-country euro zone. The youth unemployment rate is just above 50 per cent, also the zone’s highest. Both figures are greater than those of Greece, whose economy is in tatters after two bailouts and a sovereign default.

“Spain is in a critical situation,” Spanish budget minister Cristobal Montoro said Tuesday.

His warning came during a presentation in parliament of Madrid’s budget plan for 2012. Mr. Montoro said the country plans to raise €186.1-billion of gross debt this year, which translates into a net debt increase of €36.8-billion. Spain’s debt costs have been rising. For most of last year, its bond yields were well below Italy’s. Now the situation has reversed. Italy’s bond yields are fallen to about 5 per cent. Spain’s are at about 5.5 per cent, and rising.

Spain’s climbing debt and jobless rates, combined with its weak banking system and the overhang from an out-of-control construction spree that came to a sudden halt in 2008, leaving tens of thousands of apartments without owners or tenants, are reminders that the euro zone debt crisis is far from over. Spain, the zone’s fourth-largest economy, is back in recession and some economists and politicians fear it will require a bailout from the so-called troika – the European Commission, the IMF and the European CentralBank.

In late March, Citigroup chief economist Willem Buiter said in a research note, “Spain looks likely to enter some form of troika program this year, as a condition for further European Central Bank support for the Spanish sovereign and/or Spanish banks.”

Mr. Buiter, who is a former member of the Bank of England’s monetary policy committee, said Spain may lack the financial strength to recapitalize the domestic banks, which are still hurting from the housing collapse. Fresh data shows that toxic loans – bank loans that are at serious risk of default – have gone from 1 per cent of outstanding loans in 2008 to 7.6 per cent today. The value of potentially dud loans is €136-billion, equivalent to 13 per cent of Spanish GDP.

Even though Spain risks deepening its recession by doubling up on its austerity programs, it has been under enormous pressure from the European Union and bond investors to trim its deficit. On Friday, Prime Minister Mariano Rajoy unveiled Spain’s toughest budget since 1975.

Mr. Rajoy unveiled another €27-billion in spending cut and tax increases, aimed at reducing the deficit to 5.3 per cent of GDP this year from 8.5 per cent in 2011. The cuts include a 17-per-cent spending reduction by all ministries. Foreign Affairs Minister Jose Manual Garcia Margallo called it “a war budget in absolutely extraordinary circumstances.”

Mr. Rajoy had hoped to broker a peace agreement with the EU, one that would have seen Madrid back off slightly on its deficit target. But he lost the battle and the old target of 5.3 per cent was reinstated. He feared that savage spending cuts and tax increases would increase public sector job losses, boosting the unemployment rate.

Spanish consumers are losing spending power rapidly. The austerity programs will see their regulated electricity charges rise 7 per cent. Various estimates say the Spanish economy will shrink between 1 per cent and 3 per cent this year. Among the EU countries, only Greece and Portugal will suffer worse downturns.

The Globe and mail

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