Spain Sinks Deeper Into Periphery as Debt Surges: Euro Credit

Spain Sinks Deeper Into Periphery as Debt Surges
The European Commission forecasts Spain’s debt load will climb to 78 percent of GDP in 2013, compared with a euro-area average that will have swollen to 91 percent. Photographer: Denis Doyle/Bloomberg

Spain’s debt load is set to double from where it was when Europe’s sovereign debt crisis began, eroding the economic advantages that distinguished it from the region’s periphery and helped shield it from Greek contagion.

Finance chiefs meet in Brussels today in the latest effort to save Greece from default. Spain went into the crisis with public debt of 40 percent of its gross domestic product, compared with an average ratio of 70 percent in the euro region. The European Union forecasts its debt will have almost doubled by next year, as Moody’s Investors Service says Spain is losing one of its “key relative credit strengths.”

Investors give Spain a discount of just 30 basis points on borrowing for a decade compared with what they charge Italy, down from 200 basis points at the end of last year. Spain’s 10-year yield is 5.18 percent, up 33 basis points since Feb. 1.

“Time is working against Spain and that is why deficits have to be brought down sharply before the critical 100 percent debt-to-GDP mark is breached,” said Georg Grodzki, who helps oversee $515 billion as global head of credit research at Legal & General Investment Management in London.

Aaa to A3

The European Commission forecasts Spain’s debt load will climb to 78 percent of GDP in 2013, compared with a euro-area average that will have swollen to 91 percent. Spain’s indebtedness will have increased almost two-fold since 2008, while Italy’s jumps by just 13 percentage points to 119 percent, EU forecasts show. Moody’s, which in 2001 rated Spain Aaa and Italy three steps lower at Aa3, now rates both nations at A3, four notches above junk grade.

Spain’s deficit-reduction efforts are being hobbled by a relapse into its second recession in as many years. The International Monetary Fund expects the economy to contract 1.7 percent this year, preventing the nation from meeting its budget goals. The deficit, which the government estimates amounted to 8 percent last year, will narrow to 6.8 percent this year and 6.3 percent in 2013, the Washington-based lender forecasts. The goal for this year agreed with the EU is 4.4 percent.

The debt load may also swell as the government offers support to lenders as it tries to clean up a banking system saddled with 175 billion euros ($230 billion) of troubled assets linked to real-estate.

Bank Support

The government plans to buy from banks bonds that convert into equity under certain conditions, it said on Feb. 2, without saying how much it may have to spend. The bank-rescue fund, known as the FROB, has the capacity to borrow as much as 90 billion euros and the debt it sells counts as public borrowing.

“The problem with Spain lies with the hidden risk from the potential transfer of banks’ debt to the state’s balance sheet,” said Thomas Costerg, an economist at Standard Chartered Bank in London. “The government is skating on thin ice.”

Members of Prime Minister Mariano Rajoy’s government, in power since Dec. 21, have said the nation will struggle to meet the 4.4 percent deficit target this year while the economy shrinks. The 8 percent shortfall estimated for last year compares with the previous administration’s target of 6 percent.

Abundant Liquidity

A “discussion” on the goals between Spain and its European partners will start after the commission publishes its growth forecasts on Feb. 23, Economy Minister Luis de Guindos said last week. EU Economic and Monetary Affairs Commissioner Olli Rehn urged Spain on Feb. 14 to spell out what additional austerity steps it will take on top of the 15 billion euros of tax increases and spending cuts announced in December.

“For now, abundant liquidity is overwhelming fundamental concerns such as deficit over-shooting, but the latter will again come into sharp focus later this year,” said Michael Derks, chief strategist at FXPro Financial Services Ltd. in London.

As three-year loans to banks by the European Central Bank underpin demand for government bonds, Spain has raised about 30 percent of its planned bond issuance for 2012, according to UBS AG. Still, the Treasury paid an average of 3.332 percent to sell three-year bonds at its most recent auction on Feb. 16, compared with 2.861 percent two weeks earlier, reflecting the 33 basis-point rise in yields on the existing 2015 bonds.

“The markets have been paying insufficient attention to the fundamentals,” said Nicholas Spiro, managing director of Spiro Sovereign Strategy in London. “The recent uptick in the secondary market could be a foretaste of things to come if the Greek crisis escalates further.”

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