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Draghi’s Bond Rally Masks Debt Doom Loop Trapping Spain

Draghi’s Bond Rally Masks Debt Loop Trapping Spain’s Rajoy
Mario Draghi, president of the European Central Bank. Photographer: Ralph Orlowski/Bloomberg

The bond rally that has sent Spanish borrowing costs to 10-month lows has distracted attention from the nation’s growing debt pile.

Spain’s budget deficit probably exceeded 9 percent for a fourth year in 2012 as Europe’s highest unemployment rate, a third recession in four years and the cost of bailing out its banks offset almost all of the government’s 62 billion euros ($83 billion) of spending cuts and tax increases, according to economists at Societe Generale SA, Lombard Street Research and the Madrid-based Applied Economic Research Foundation.

Total debt will reach 97 percent of gross domestic product this year, the International Monetary Fund forecasts.

“This is a classic example of the doom loop,” Societe Generale’s London-based chief European economist, James Nixon, said in a Jan. 10 telephone interview. “They just aren’t making any progress.”

The last time Spanish debt was trading at this level, with 10-year yields around 5 percent, was early March 2012 after European Central Bank President Mario Draghi flooded the banking system with more than a trillion euros. Spanish Prime Minister Mariano Rajoy shattered that calm when he surprised European leaders March 2 by rejecting the country’s deficit target just hours after signing a treaty on budget discipline.

“It’s very difficult to have promised at home and abroad a deficit of 6 percent and to end up recognizing that you have almost 9 percent,” Deputy Prime Minister Soraya Saenz de Santamaria said today, referring to the 2011 budget figures delivered by the previous Socialist administration. Rajoy pledged to deliver a deficit of 6.3 percent for 2012.

‘Recovering Confidence’

“We are recovering confidence and credibility which is something that is lost very quickly and is difficult to regain,” Saenz added in an interview on Antena 3 television.

The Spanish Treasury sold 5.75 billion euros of 12- and 18-month bills today, exceeding its target of 5.5 billion euros.

The European Union has eased the pressure on Spain to deliver its deficit goals. EU budget enforcer Olli Rehn endorsed Spain’s efforts through the end of this year even as he forecast the shortfall will exceed the targets set, strengthening the support for Spanish securities.

Spanish 10-year bonds were little changed today, with the yield at 5.03 percent at 10:50 a.m. in Madrid. It reached a 10-month low of 4.8 percent on Jan. 11, down from a euro-era record of 7.75 percent in July.

Unresolved Issues

“The market is ignoring unresolved macro issues,” Alberto Gallo, head of European macro credit research at Royal Bank of Scotland Group Plc in London, said in an interview last week. “Spain is not sustainable.”

Investors are being drawn back to Spanish debt as the ECB pledge curbs the risk of paper yielding three times more than German bunds. The Treasury exceeded its target as borrowing costs tumbled at the first bond auction of the year last week.

Those results will probably give Rajoy enough cash to avoid a bailout during the first quarter and it may retain its financial independence so long as the global economy holds, Gilles Moec, co-chief European economist at Deutsche Bank AG in London, said in a note last week.

“The Spanish sovereign started 2013 with a bang,” Moec said. Still, “the overall positivity surrounding the periphery at the moment could be easily reversed for instance if disappointing deficit data for 2012 jeopardizes the credibility of the fiscal plans for 2013.”

Rajoy’s Austerity

Rajoy last year introduced five austerity packages he forecast would deliver 62 billion euros of savings in 2012 from cuts in public wages, jobs, unemployment benefits, health care and education spending. Those expectations have been dashed as Spain fell into recession, increasing unemployment costs and depressing government receipts.

The tax increases -- on income, savings, property, companies, sales, tobacco and fuel -- added 7 billion euros of revenue through November, according to the tax agency. The government estimate was for 20 billion euros.

Overall, tax income rose 1.1 percent in the first 11 months to 153 billion euros. Non-financial costs for the central government were unchanged at 136 billion euros, the tax agency said.

The outlook for 2013 is even worse because Christmas bonus payments for public workers are due to be restored and pension costs will increase, adding about 10 billion euros of spending, according to Ignacio Conde-Ruiz, an economist at the Applied Economic Research Foundation in Madrid. The EU has asked Spain to cut its shortfall to 4.5 percent.

“The target for this year is impossible,” Conde-Ruiz said in an interview. “It’s going to be a very, very complicated year.”

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