Analysts warn bailout debts may hurt Spain

 
Tim Wallace
Follow Tim
INTERNATIONAL Monetary Fund (IMF) boss Christine Lagarde welcomed Spain’s bailout deal as “key” to the financial sector’s future stability.

But analysts warned that it may offer only temporary reprieve from the strains of the sovereign debt crisis, in part because the deal adds up-to €100bn (£81bn) to Spain’s already dangerously large public debt.

“Providing a credible back stop to recapitalise weaker segments of the banking system has been a key recommendation of the IMF’s recent Financial Sector Assessment Program (FSAP) conducted in Spain,” said Lagarde.

“This scale of proposed financing, which is consistent with the capital needs identified in the FSAP, gives assurance that the financing needs of Spain’s banking system will be fully met.”

However, it is exactly the scale of the support that worries other observers.

Prime Minister Mariano Rajoy has been pushing hard to cut the government’s budget deficit and put it on a sounder long-term financial footing – but is now borrowing an extra €100bn to recapitalise the country’s banks.

“The burden of recapitalising insolvent banks or loss-making acquisitions of solvent banks will fall on Spanish citizens,” said Karl Whelan, economist at University College Dublin.

“For this reason, this weekend’s announcement may well end up shutting Spain out of the sovereign bond market.”

Ratings agency Fitch downgraded Spain last week from A to triple-B in part thanks to the expected cost of the bank recapitalisation, and economist Jose Carlos Diez from Intermoney warned more cuts were to come.

“We’re very close to junk bonds and we’ll end up in the junk,” he said.

The national debt stood at 68.5 per cent of GDP at the end of 2011, and was already forecast to hit 78 per cent at the end of this year. An additional €100bn would push that up to over 87 per cent by the end of the year.

Q and A: How will the Spanish bailout work?

Q Where is the €100bn coming from?

A The Eurozone has two bailout funds – the temporary European Financial Stability Facility (EFSF), which is up and running now, and the permanent European Stability Mechanism (ESM), which is expected to be available next month. They are guaranteed by governments, and issue bonds to raise money.

Q Does it matter which fund gives the money?

A Yes – debt owed to the EFSF is “normal” debt. Debt from the ESM will be “senior” debt. If a debtor cannot pay off all of its loans, the senior debt must be paid off first. Some analysts fear using senior debt will make other investors scared to lend the banks money, as their loans will be deemed less important than those of the ESM. Also, the ESM is the larger, with a lending capacity of €500bn to the EFSF’s €440bn.

Q How does the bailout work?

A The funds can only give money to governments, not banks. That means the Spanish government will take the bonds and pass them on to the banks. They will then pass them to the European Central Bank in return for liquidity, solving their current problems.

Q How much is left?

A The EFSF has a lending capacity of €440bn. It has already committed €192bn to Ireland, Portugal and Greece. The latest loan could total €100bn. That leaves €148bn. When the other countries took funding from the EFSF, they ceased to be guarantors. If Spain does the same, the facility’s total lending capacity will drop to €387bn – leaving just €95bn for future rescues.