independent

Wednesday 16 April 2014

Julien Toyer: Mariano Rajoy’s delays asking for aid prolonging pain in Spain

THE longer Prime Minister Mariano Rajoy puts off asking for aid from the eurozone, the greater the risk of further financial turmoil and an even worse recession in Spain, analysts say.

Promises of help from the EU and the European Central Bank have brought Spain's borrowing costs down from unsustainable levels in the past few months.

But ironically, if Rajoy is persuaded by the improved market conditions that he no longer needs to ask for help, it could make the situation worse.

A government source told Reuters today that the prime minister had not ruled out applying for a rescue, but deficit cutting progress at home and EU movement toward a banking union both give the government breathing room.

"That doesn't mean we won't ask for it, but we don't see it necessary (right at the moment)," the source said. Earlier this month another source familiar with Rajoy's thinking told Reuters that Spain will seek aid, but will not rush into it.

Under the proposed programme, countries such as Spain could seek aid from the European rescue fund, the European Stability Mechanism, which would trigger bond buying by the central bank to stabilise borrowing costs.

The central government is already 95pc funded for 2012 and will begin pre-funding 2013 in bond sales this year, which seems to give Rajoy breathing room to delay a decision.

But analysts say putting off a request for a precautionary credit line is wasting precious time to fix the euro zone's fourth biggest economy, already shrinking for five quarters.

Uncertainty has frozen business investment, and job destruction is expected to continue next year, worsening an unemployment rate already at 25pc .

The delay gives time for doubt to surface among investors whether the ECB plan will do more than buy Spain a few months before it needs a full bailout. Madrid could see its sovereign debt downgraded to junk status, lose market access and be pushed into a fully fledged rescue that would come with more drastic conditions than those attached to the credit line now on offer.

MAIN FOCUS OF CRISIS

Spain has been the main focus of the three-year-old euro zone debt crisis for the last nine months and has already obtained a credit line of up to €100bn for its banks.

After jumping higher than 7pc in July, the yield on Spain's benchmark 10-year bond has come down in anticipation of ECB action and is currently about 5.6pc.

Yet the dominant view among investors, analysts and sources involved in talks on the issue is that the market relief is only temporary unless the ECB actually acts.

"We disagree with those who believe a bailout is not needed. We think there is no other way out except a bailout," said Credit Agricole-Cheuvreux in a note last week.

Italian Prime Minister Mario Monti said this week that in order to restore confidence, the ECB bond-buying needed to be real, not just a plan. The International Monetary Fund expressed a similar view earlier this month.

Diplomatic sources say French President Francois Hollande has also applied pressure on Rajoy to take the bailout.

Senior business executives have been calling publicly on the government to press ahead with the rescue, as have Spain's two biggest lenders, Santander and BBVA.

Two senior euro zone officials with direct knowledge of the matter said earlier this month that they and others were preparing the ground for a request to be made in November.

However, Rajoy has given continued signs he will not rush unless market conditions take a significant turn for the worse.

The prime minister has built his career on caution, said a Spanish economist who asked not to be identified: "Rajoy believes time cures everything, that's his signature strategy, his genetic trait."

Rajoy also has domestic resistance to consider. A rescue could come with demands for more budget cuts, opposed by demonstrators who march in the capital several times a week.

Sources familiar with Rajoy's thinking have said he wants to make sure conditions attached to a rescue are minimal, and that the aid would not just create more risks for Spain.

Savings from previous austerity measures, which include public wage cuts and lower spending on schools and hospitals, have so far been eaten up by higher unemployment and social security payments and interest payments on public debt.

MULTIPLE PRESSURES

Spain's central government must raise €207bn in debt next year, plus a possible additional €20bn to cover finances of indebted regional governments. Analysts say it may be tough to meet those needs without external aid.

The 17 self-governing regions have been shut out of debt markets for months and nine have so far tapped a state liquidity line for around €17bn. More could join the queue.

Even more pressing are the needs of the private sector. Spanish firms dashed into the bond market in September after interest rates dropped.

They now have some breathing space as they've refinanced some debt maturing in 2013. But they remain worried about both ratings and market access if a bailout is delayed.

There are already signs markets are losing patience. The spread between German and Spanish benchmark bonds - showing the perceived risk of investing in Spain - now stands at around 414 basis points, far below the figures of more than 640 basis points reached in July but still stubbornly high.

"The rally has stopped. The Spanish spread has found a floor at a bit more than 400 basis points. This could be gradual but the upward trickle has started," said Jose Carlos Diez, chief economist at Intermoney brokerage.

Although few analysts believe investors will bet against the ECB when it may be only one step away from intervening massively to buy bonds, some of them think Spain runs the risk of losing market access. Debt rating agencies Standard & Poor's and Moody's have both hinted they could downgrade Spain to junk if the rescue doesn't materialise.

Analysts at Citi expect Spain to lose its prized investment grade over the next 6-9 months, even with European support.

Spaniards continue to suffer. Most forecasts are for the economy to shrink a further 1.5pc next year. Inflation is rising due to a hike in the value-added and other taxes.

The bleak outlook carries high risks for the ECB plan, with some analysts saying it could fail to restore market confidence for more than a few months. Were the ECB to start buying bonds, it could not stop without devastating consequences.

"The market effect might be short, one month or two but a rescue has to work over two years," Diez said. "In six months time you might be discussing a full-blown rescue. To avoid that, the ECB will have to fulfil its pledges and buy (bonds) every week... And if it buys and then stops, then you're in trouble."

Reuters

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