OVER the past week, the crisis in Spain has reached a critical level. Fortunately, thanks to hints of further European Central Bank (ECB) intervention from ECB President Mario Draghi yesterday, the situation has abated somewhat. Unfortunately, this relief will probably only be temporary – not only because Draghi’s comments are unlikely to be followed up with decisive action, but more importantly because of the political and economic pressures facing the Spanish state in coming months.
Much of the recent market jitters stem from concerns over a potential string of regional government bailouts by the Spanish state. There is no doubt that the regions have problems, but they will not make or break Spain financially. Some, like Catalonia, which needs to refinance €5.7bn (£4.2bn) in debt before the end of the year, do face immediate funding pressures. We also expect seven of the 17 regions to miss their deficit targets, thereby forcing the Spanish state to miss its own overall target. In total, though, we estimate that these factors would add an additional €20bn to Spanish funding needs – not a pittance, but only 2 per cent of Spanish GDP.
The main concern should be that, with Spain continuing to miss deficit targets, it is losing the trust of Eurozone leaders and financial markets. Questions over whether Spain can control its regional spending over the medium and long term will also linger.
Possibly more worrying is that Spain faces refinancing needs of €542bn over the next three years, on top of the €100bn already earmarked for its banking sector (which may yet prove insufficient). Up to €78bn of this could fall due before the end of the year.
Combine these factors with a bank rescue package that is struggling to get off the ground, sky-high unemployment and swingeing budget cuts, and it is hard to see how some form of financial aid for the Spanish state will be avoided – especially if borrowing costs begin rising again. But what format could this aid take?
A full bailout programme, to remove Spain from the markets for three years, could cost between €450bn and €650bn – making it both economically and politically impossible for the Eurozone. Spain is also likely keen to avoid the stringent conditions and stigma associated with such a package. The most likely outcome seems a combination of a precautionary loan covering Spain for around a year (which we estimate would need to total €155bn) and another ECB Long Term Refinancing Operation (LTRO), albeit with lower rates and looser collateral rules. This is far from a perfect solution and will only buy Spain some time. However, it is likely to appeal to Eurozone finance ministers as they look to grander plans of a banking and fiscal union.
Spain’s regional problems will not be the main cause of any future bailout. That will come down to poor economic policies and a botched banking sector rescue. But Spain’s regions could well be the trigger for further crisis.
Raoul Ruparel is the head of economic research for Open Europe.