Spain Remains A Basket case

Aside from the Greek circus, Spain is now the cockpit of the eurozone government debt crisis. How does Spain look as she confronts the need for a big bailout?

For the sake of this discussion, let’s agree that the ratio of government debt to GDP is a good measure of sovereign risk. Both government debt and GDP are nominal figures; no complicated constant dollar calculations are required. Government debt grows at the rate of beginning period debt plus the current year’s fiscal deficit in current dollars. For the D/GDP ratio to stabilize, nominal GDP must grow at the same rate as the deficit as a percent of GDP. Not rocket science.

Let’s take a look at Spain’s numbers.

Spain’s nominal GDP (EUR B), as calculated by the OECD, has been pretty flat:
2006: 986
2007: 1,053 (+7%)
2008: 1,088 (+3%)
2009: 1,048 (-4%)
2010: 1,048 (+0%)
2011: 1,063 (+1%)

Spain’s general government fiscal deficit as a % of GDP as calculated by Moody’s has been high:
2007 (+1.9%)
2008 (-4.5%)
2009 (-11.2%)
2010 (-9.3%)
2011 (-8.9%)
2012 (-6.6%) est.

Spain’s central government debt (EUR B), as reported by the Tesoro Publico, has grown rapidly:
2007 307B
2008 358 (+17%)
2009 475 (+33%)
2010 540 (+14%)
2011 592 (+10%)
2012 605 (July) (+2%)

The World’s Opinion Page

Help support Project Syndicate’s mission

subscribe now

Spain’s general government debt to GDP ratio (%) as calculated by the Fed has risen by 250%:
2007 36%
2008 40% (+4%)
2009 54% (+14%)
2010 61% (+7%)
2011 69% (+8%)
2012 91% (proj.) (+22%)

That is what the ECB is facing, as it seeks to facilitate Spain’s effort to become a creditworthy sovereign issuer. Spain’s numbers are all going in the wrong direction. The ECB can help to refinance Spain’s maturing debt at affordable rates (if it tries hard enough). But it can do nothing about Spain’s large fiscal deficit, which only the government (with the Troika’s help) can fix. And the ECB has announced no plans to raise the eurozone’s rate of inflation or the rate of nominal GDP growth. The outlook is grim.

Looking forward, Spain’s nominal GDP growth outlook is at best modest (zero?), while its fiscal deficit is unlikely to get much below 5-6% of GDP, despite whatever cuts Spain eventually agrees to. Thus, the medium-term outlook for Spain’s debt ratio is a steady annual increase, in the direction of higher credit risk, lower credit ratings, and higher bond spreads. Spain will remain a deteriorating credit until its budget comes into a sustainable balance and its GDP starts to grow in a sustainable way. Neither are likely without much higher inflation in the eurozone (which had been experiencing deflation until recently).

Moody’s currently rates Spain at the bottom of investment grade (Baa3), with the rating under review for possible further downgrade (to junk). In a recent comment on the continuing review for downgrade (expected to end soon), Moody’s sounded pessimistic in observing that:
“official support beyond banking recapitalisation but short of a full package may also pressure the rating below investment-grade if (1) the combined measures were unlikely to succeed in maintaining ample market access; or (2) if these measures were effectively providing the bulk of the Spanish government's funding needs through crisis-management tools such as the European Financial Stability Facility and ESM, and European Central Bank actions that provide liquidity to government debt markets. Short of the accompanying fiscal and structural reforms being successful, full return to market access at the end of these initiatives may prove very difficult, raising the risk of private sector participation in a debt relief effort before more official support is provided.”

That sounds to me that Moody’s will either downgrade Spain or extend further its review (begun three months ago). Most likely they will take the rating to Ba2/negative outlook (which won't lower bond yields).

My overall conclusion is that while the OMT can help to overcome the market’s reluctance to buy Spanish debt, it can’t fix Spain debt trajectory. That can only be done by politically unpalatable austerity combined with massive unsterilized QE by the ECB. By sterilizing the OMT program, the ECB has condemned Spain to a future of zero growth, weak government revenue, and rising debt ratios. Let us hope that Bernanke’s QE3+ will succeed, and provide a model for the ECB before it is too late.;
  1. Television sets showing a news report on Xi Jinping's speech Anthony Wallace/Getty Images

    Empowering China’s New Miracle Workers

    China’s success in the next five years will depend largely on how well the government manages the tensions underlying its complex agenda. In particular, China’s leaders will need to balance a muscular Communist Party, setting standards and protecting the public interest, with an empowered market, driving the economy into the future.

  2. United States Supreme Court Hisham Ibrahim/Getty Images

    The Sovereignty that Really Matters

    The preference of some countries to isolate themselves within their borders is anachronistic and self-defeating, but it would be a serious mistake for others, fearing contagion, to respond by imposing strict isolation. Even in states that have succumbed to reductionist discourses, much of the population has not.

  3.  The price of Euro and US dollars Daniel Leal Olivas/Getty Images

    Resurrecting Creditor Adjustment

    When the Bretton Woods Agreement was hashed out in 1944, it was agreed that countries with current-account deficits should be able to limit temporarily purchases of goods from countries running surpluses. In the ensuing 73 years, the so-called "scarce-currency clause" has been largely forgotten; but it may be time to bring it back.

  4. Leaders of the Russian Revolution in Red Square Keystone France/Getty Images

    Trump’s Republican Collaborators

    Republican leaders have a choice: they can either continue to collaborate with President Donald Trump, thereby courting disaster, or they can renounce him, finally putting their country’s democracy ahead of loyalty to their party tribe. They are hardly the first politicians to face such a decision.

  5. Angela Merkel, Theresa May and Emmanuel Macron John Thys/Getty Images

    How Money Could Unblock the Brexit Talks

    With talks on the UK's withdrawal from the EU stalled, negotiators should shift to the temporary “transition” Prime Minister Theresa May officially requested last month. Above all, the negotiators should focus immediately on the British budget contributions that will be required to make an orderly transition possible.

  6. Ksenia Sobchak Mladlen Antonov/Getty Images

    Is Vladimir Putin Losing His Grip?

    In recent decades, as President Vladimir Putin has entrenched his authority, Russia has seemed to be moving backward socially and economically. But while the Kremlin knows that it must reverse this trajectory, genuine reform would be incompatible with the kleptocratic character of Putin’s regime.

  7. Right-wing parties hold conference Thomas Lohnes/Getty Images

    Rage Against the Elites

    • With the advantage of hindsight, four recent books bring to bear diverse perspectives on the West’s current populist moment. 
    • Taken together, they help us to understand what that moment is and how it arrived, while reminding us that history is contingent, not inevitable

    Global Bookmark

    Distinguished thinkers review the world’s most important new books on politics, economics, and international affairs.

  8. Treasury Secretary Steven Mnuchin Bill Clark/Getty Images

    Don’t Bank on Bankruptcy for Banks

    As a part of their efforts to roll back the 2010 Dodd-Frank Act, congressional Republicans have approved a measure that would have courts, rather than regulators, oversee megabank bankruptcies. It is now up to the Trump administration to decide if it wants to set the stage for a repeat of the Lehman Brothers collapse in 2008.