The Greek elections have taken that sorry country out of the limelight for a while, leaving Spain the focal point of the euro crisis. And Spain really is where it is all happening.
Given the high degree of sovereign rollovers – €300 billion to €400 billion or 30% to 40% of GDP to end-2014 – and large dependence on foreign funding for all sectors’ debts – 16% of GDP – a closure of financial markets to Spain is a hair’s breadth away. This makes a full troika programme likely.
Sovereign liabilities, including arrears and contingent liabilities, are about 100% of GDP, even before bank recapitalization and further budget deficits in 2012 and 2013. Debt sustainability needs between 3.5% and 4% nominal GDP growth, borrowing costs below 5% and a primary surplus of 1.5% of GDP.
Instead, Spain has falling employment and wages, house prices down 27% – with 20% to go – net household worth down 20%, and more to go. These depressants and deleveraging will keep the economy shrinking.
The banking bailout package is poorly designed. It contaminates the sovereign with bank liabilities. There will be market-unfriendly delays as the government wants to wait for funding by the new European Stability Mechanism (ESM) and to do a full audit using international auditors instead of its own excellent Bank of Spain inspectors, who have been prevented from doing their job for the past three years.
So, there is a big clean-up job before we can be sure the €100 billion package is enough. Indeed, another €20 billion to €40 billion will probably be needed because non-performing loans will worsen from the recession and affect a wider range of bank assets than are covered by provisions.
The reform of banks is the mirror image of political and fiscal reform, as the savings banks are the financial arms of the regional governments. Cleansing both is the key to bringing Spain’s finances and fiscality under control. It is a job that will take years.
The right things are being done, but gradually. Improvement in fundamentals will be equally gradual. I doubt the market will wait.
And Spain cannot expect pan-EU economic reform measures to be introduced quickly enough to save itself from a troika programme. The euro leaders need to give a firm and binding timetable for implementation of fiscal integration.
Europe also needs a fully functioning ESM: with resources at least doubled to €1 trillion; issued with a banking licence empowering it to borrow from the European Central Bank (ECB); and allowed to recapitalize banks without recourse to the sovereign.
And it requires a eurozone bank-regulation authority that has power to determine the reorganization, foreclosure or recapitalization of banks and insurance companies, along with unlimited ECB liquidity support for sovereigns and banks to gain market credibility.
| A hair’s breadth |
| Spain’s 10-year sovereign bond yield |
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| Source: Bloomberg |
This is where Europe has to go and probably will go – but not to the increasing tempo of the beat of markets. As leaders, Europe needs architects of vision. Instead, we have plumbers. German chancellor Angela Merkel cannot agree with much, given her own constituency’s hostility to paying for Europe. Merkel has named her price for the sort of integration Europe needs. It is political integration first, and then fiscal control at a eurozone level.
The Italians, Irish, Portuguese and Spanish are fine with this, but I doubt the French will give up their sovereignty to achieve it.
Even if European integration of such magnitude were announced with a binding timetable and qualification criteria, the delay in achieving it would require unlimited backing from the ECB for an unlimited period.
Ultimately, the ECB will have to back the euro with such intervention, but I suspect this will be produced by crisis, not design.
However, the ECB is the only institution that can spend money almost ad infinitum with zero cost to the taxpayer or common man, unless the euro collapses or inflation explodes – the latter being hardly today’s imminent threat.
Yet decisive action will probably be delayed, so that Spain is forced into joining Greece, Portugal and Ireland in a troika programme.
David Roche is president of Independent Strategy Ltd, a London-based research firm. www.instrategy.com