April 17, 2012 5:32 pm

Spain weighs financing options

European Union officials insist Spain will not need financial aid. But they have been looking at contingency plans in case Spanish borrowing costs – which had eased on Tuesday – rise to unsustainable levels, despite officials insisting no such plan is imminent.

In the year since the EU last came to the aid of a struggling eurozone country – the €78bn bailout of Portugal last May – the bloc has vastly expanded its arsenal for fighting the kind of financial panic that forced Lisbon, like Greece and Ireland before it, out of private credit markets.

“With Spain, the strategy will be to do everything necessary to keep it in the market,” said Mujtaba Rahman, Europe analyst at Eurasia Group risk consultancy. “It’s unlikely to be a full programme, just additional financing at the margin.”

Bank recapitalisation:

Officials said the most likely move would be to use the eurozone’s €440bn rescue fund, the European Financial Stability Facility, to provide low-interest loans to recapitalise Spain’s teetering banking sector – as the IMF is urging.

Analysts believe Spain’s housing market has further to fall, dragging bank mortgages down with it. Daniel Gros, director of the Centre for European Policy Studies, estimated the total “overhang” of excess property was €380bn, far more than the banks have written down.

However, some officials have expressed concern about the “signalling effect” that an EFSF bank recapitalisation would have on markets – traders could panic, viewing it as a precursor to a full-scale bailout. In addition, EU officials said Berlin is opposed, having long resisted using the EFSF to help banks.

But Guntram Wolff, economist at think-tank Bruegel, said such fears were overstated and markets would probably be heartened by a cleaned-up banking sector that could begin lending again to bolster economic growth. “That’s what the EFSF is for,” Mr Wolff said. “I don’t think there is any other solution.”

ECB bond buying:

Before the EFSF was given such powers, the only tool short of a full-scale bailout was the European Central Bank buying sovereign bonds, driving down borrowing costs for countries auctioning debt on the private market.

The ECB has halted such purchases but officials have left the option open. Benoît Cœuré, an ECB executive board member, said last week that the programme “still exists”, triggering speculation that action could be imminent – almost certainly an over-interpretation.

Within the ECB there is scepticism about the programme’s effectiveness – not only among German policy makers, who warn that such purchases take pressure off reform-weary governments, but also from Mario Draghi, ECB president.

In addition, the €200bn Greek debt restructuring, where the ECB avoided losses on bonds it purchased, has led some officials to believe ECB intervention would be unwelcome, because it would effectively insert a protected creditor into the market.

“Because of the way they behaved in Greece, it is unclear whether investors would be pleased with ECB intervention,” said one EU official.

Revised deficit targets:

Under EU-mandated targets, Spain must reduce its budget deficit to 3 per cent of economic output next year – a huge undertaking given 2011’s deficit of 8.5 per cent. Madrid has already cut €27bn from its 2012 budget, leading some to worry the drive will push Spain deeper into recession.

In depth

Eurozone in crisis


Storm clouds blow towards Italy and Spain as eurozone leaders seek a resolution to the sovereign debt crisis

The European Commission is due to review Spain’s deficit targets after Eurostat, the EU statistical office, releases its review of eurozone figures next week. Some officials have advocated an easing, including delaying the 3 per cent target by a year.

“There’s a difference between what ought to be done and what will be done,” said the EU official. “In terms of what ought to be done, it’s slowing down austerity.”

The IMF has indicated it could be supportive. “If [economic] activity was too slow, I would be reluctant to agree to further fiscal consolidation,” Olivier Blanchard, the IMF’s chief economist, said on Tuesday.

But the Commission is reluctant to ease up on Spain, a large EU member, after coming down hard on smaller countries such as Belgium and Hungary. Northern eurozone countries would be likely to block such a move.

“I put austerity first,” Alex Stubb, Finland’s EU minister, said. “Only austerity can give back growth.”

Additional reporting by Ralph Atkins in Frankfurt, Guy Dinmore in Rome and Claire Jones in Washington

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