European Debt: Focus on Spain

Spain is at the heart of the European debt crisis. In the space of one year, Spain’s long term credit rating was reduced from AAA to AA, with a negative outlook.

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Spain is at the heart of the European debt crisis. At the beginning of 2009, the Credit rating agency Standard and Poor’s, decreased the long-term debt rating from AAA to AA + and a year later the agency downgraded it one notch further to AA with a negative outlook. The country is in a precarious situation, particularly with the collapse in the construction industry, and then the global economic crisis of 2008 which has only served to aggravate the situation. In a country ,very dependent on the housing construction industry, this sector represents nearly 20% of the GDP and employs nearly 12% of the active population.

The current crisis is characterised by a steep rise in unemployment affecting more than 20% of the active population in 2010 against about 8% two years earlier. The banking system is equally to blame, in particular savings banks which represent 50% of the Spanish financial sector. The Bank of Spain has just completed a second rescue of a regional savings bank after having already rescued the savings bank of Castilla-la-Mancha in March 2009. Four banks have, at the same time, announced that they have created a holding company which will become the fifth Spanish lender. But this announcement does not specify if there will be budget cuts, when this is what the market expects.

With the fiscal situation, now appearing more fragile than expected, additional austerity measures are necessary. The government has now initiated an austerity plan designed to reduce the public deficit from 11,2% of GDP in 2009 to 6% in 2011 and 3% in 2013. (as a reminder: Spain enjoyed a positive budget surplus in 2007 of +2,23%). To achieve these aims, the Spanish government will have to significantly reduce its administrative costs or increase its tax revenues. This tax increases should mainly affect businesses so as not to affect the consumer. The measures include a reduction in the unemployment rate, a reform in the labour code (a reduction of dismissal costs, an end to inflation-linked indexation of wages, a decentralization of wage fixing with a view to reducing inflation and increasing the per capita GDP.

The small contribution made, to Spain’s GDP, by exports is, in itself, a serious problem Exports, in fact, only represent 25% of the GDP, whereas in Germany exports represent 55%. It’s all the more penalizing in that a way out of the crisis will be to export to emerging countries which show very high growth rates. The first European States to resume sustainable growth, may well be those who take advantage of the weakness of the Euro in order to conquer new markets. It is therefore necessary now, more than ever before, that the Spanish government orientate its trade policy towards this method of growth.

This austerity programme seems difficult to achieve today, but it must be remembered that since its entry into the European Union (1986), the exposure of the country’s economy has led to the modernization of its industry, improvement of its infrastructure and revision of its legislation, thus enabling Spain to accelerate its GDP growth, reduce its public debt and lower its employment rate to 8% in three years.

Its debt is still just under the EU’s recommended 60% threshold, unlike Portugal’s colossal debt of over 85% and Greece’s 110%. It has, incidentally, increased significantly from 36,2% in 2007 to 55,2% in 2009 and is expected to jump to 74,3% in 2012, according to Spanish government predictions. This is why Spain must act quickly.

The IMF has also indicated that it predicts a 0,4% decline in the GDP in 2010 before an increase of 0.9% in 2011. The outcome of this will be crucial for the 4th European economy.

Since the beginning of the year, the IBEX 35 lost 23,5%, making the European index the lowest, just ahead of the Greek index which lost 33,3% in 2010. The Portuguese index lost 20,5% whilst the CAC 40 was down to just over 13% since the beginning of the year. The weakness of the Spanish index is easily explained by the sectors it encompasses being largely focussed on retail banking and telecommunications. These two sectors which represent around 50% of the IBEX 35, are among the weakest sectors since the beginning of the year, with declines of 13,5% and a little over 10% respectively.

In the short term, we set ourselves a target of 8100 points (major support) on the IBEX 35, a decrease of approximately 11,4% from the current level of 9140 points.

Philippe de Vandière , May 2010

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