Spain is under ever-increasing pressure. Yesterday, the sovereign’s bond yield curve inverted, with five-year borrowing costs heading north of ten-year borrowing costs. The country has also been forced to announce plans for an €18 billion rescue fund to shore up fiscal slippage in the country’s so-called autonomous communities. Spain’s regions account for just under 40% of public expenditure in the country and much of this spending is on long-term programmes with structurally 'sticky' recurrent expenditure, such as healthcare and education.
Muddying matters, there is concern over how Spain's regional bailout fund will be financed. Of the €18 billion number, €6 billion is coming from the state-owned lottery and the rest will come from the government. Yet the proposal for the mechanism insists that this will “not alter the Kingdom of Spain’s funding programme for the year”. That's particularly confusing given that the same proposal notes that: “The Central Government will add the funding needs of participating regions to its funding programme”.
As a Credit Suisse research report puts it: “Magic. Spain is struggling to fund itself, but will find an extra €12 billion for its regions when they aren’t able to themselves.” A likely possibility is that the funding will be provided by the Instituto de Crédito Oficial (ICO), a government bank that lends to businesses, or another agency. This wouldn’t be a material difference: the ICO is government-backed and funding through the ICO will still increase Spain’s debt-to-GDP ratio. This is very much a question of semantics.
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| Last Friday, Valencia became the first Spanish region to confirm it would seek aid from the central government |
However, the Spanish central government may have some room to manoeuvre, due to money accrued from social security programmes that over the years have been running a surplus. “The government has access to some rainy day funds, including the €67 billion reserve fund,” says Ruben Segura-Cayuela, an economist at Bank of America Merrill Lynch.
This surplus could be used by the central government to pay for social security liabilities while the money earmarked by the government to pay for these programmes in its budget this fiscal year could fund the new regional bailout mechanism - though this is likely to be a last-resort option.
Not only is there uncertainty over where the money will come from, there is little clarity on whether it’s going to be sufficient. There have already been conflicting accounts of whether the small region of Murcia will tap the bailout fund or not. With the deteriorating economic situation in Spain and with some of the most indebted-regions being named as possible applicants to the fund, there is the possibility that the bailout fund may prove insufficient. “Given the economic backdrop in Spain we think the risk is that the current deficit targets for the regions are missed and in excess of €18 billion funding is required. In the past these numbers have been underestimated,” says Michelle Bradley, an economist at Credit Suisse.
Also problematic is the increased central government oversight that is expected to come as part-and-parcel with any applications to the fund. Increased centralization of power is unlikely to go down well with the governments of Spain’s autonomous communities – particularly in regions like Catalonia or the Basque Country.
“Creating policy is one thing, implementing it is another,” says Bradley.
Ultimately, however, with the capital markets closed to the majority of the regions and the caixas that typically provide loans to them downsizing balance sheets, at least some of the autonomous communities may have no choice but to submit to further government oversight. BAML's Segura-Cayuela doesn't hold out hope for any Spanish regions keeping their distance from the new mechanism:
“Some regions, like Madrid, have issued small quantities this year. But I would expect all regions to ask for the plan sooner than later, particularly the ones with large [debt] maturities.”