Portugal’s agreement with the EU and IMF regarding a financial assistance package is likely to refocus attention on contagion risks to Spain. The consensus view recently has been that Spain has “decoupled” from its financially distressed peers in the eurozone’s periphery – but is this optimism misplaced?
Stephane Deo, economist at UBS, says the markets seem to be giving the benefit of the doubt to Spain for the time being. “The situation is far less worrying than in the three countries that have requested help,” he says.
“We reiterate our long-standing view – the Spanish economy is stabilising, not collapsing. We think the fiscal situation is indisputably worrying, but if the government takes proper action, a stabilisation of the situation should be within reach.”
But he adds: “The ongoing issue of the banking crisis remains, although we note that on a number of metrics, the scale of the issue is considerably smaller than in Ireland. This is not enough, however, to shelter Spain from a similar fate.
“In short, we believe the market and the government could fund the financial system; in practice it depends on whether liquidity is available. There is, to a large extent, a self-fulfilling element in the situation. Tackling the problem faster and adequately to reassure the market could prove extremely important.”
Jamie Dannhauser, economist at Lombard Street Research, believes the ability of Spanish bonds to decouple from the rest of the eurozone periphery is unlikely to last.
“Although economic activity has stabilised, companies are still shedding workers at a rapid clip, the rate of job creation continues to fall and business confidence remains fragile given the steep overghang of debt.
“Fiscal consolidations must ultimately go hand in hand with solid economic growth if they are to be successful. Neither households nor foreigners seem reliable candidates for stimulating the Spanish economy. What is true of these two sectors is doubly true of the Spanish business sector, given its extensive balance sheet and financing problems.
“There is a good chance that the planned fiscal tightening, more severe than in 2010, backfires. Downside surprises to Spanish economic data could be a wake-up call for the sovereign debt markets.”
Nicholas Spiro at Spiro Sovereign Strategy argues that as well as the snail-like pace of restructuring at some regional savings banks, the key issue is the decentralised nature of the Spanish state.
“Just as Greece has to overcome chronic fiscal mismanagement and Portugal must contend with an enduring loss of wage competitiveness, Spain has to cope with the legacy of a lopsided growth model based largely on residential investment and construction and 30 years of increasing political and fiscal decentralisation.
“While the former requires a long and painful adjustment to purge past excesses, the latter makes it more difficult to manage and enforce economic reform.
“Since emerging from dictatorship in 1975, Spain has gone from being one of Europe’s most centralised states to one of the most decentralised. The spending share of sub-national governments as a proportion of total government expenditure is now among the highest in the OECD.
“Weak spending controls on sub-national governments induced expansionary fiscal policies during the 2003-7 boom, making it more difficult for the regions to rein in their budget deficits in the downturn.”