Business World

Friday 20 September 2019

The euro is in his hands

Under massive pressure from the markets, the response of the premier in Madrid is likely to decide the currency's future

SPANISH prime minister Mariano Rajoy is the man who holds the future of the euro in his hands. With his country's banks needing hundreds of millions of euro in fresh capital, the fate of the single currency may well be decided in Spain.

Bankia, Spain's fourth-largest bank, is rapidly turning into an Iberian equivalent of Anglo. When the lender's problems first emerged early last month, the Spanish government reckoned that a €4.5bn cash injection would do the trick.

As the full extent of Bankia's problems have emerged -- not least €32bn in distressed loans to property developers -- the likely cost of fixing Bankia has risen exponentially, with the Spanish government now proposing to inject a further €19bn into the troubled lender.

When the €4.5bn that it pumped into Bankia early last month is added, this brings the total cost so far to €23.5bn.

Further complicating matters is the deep involvement of Mr Rajoy's Partido Popular (PP) in the Bankia fiasco. Bankia was formed in December 2010 from the merger of seven local savings banks.

Each of the 17 autonomous regions in Spain has its own local savings bank and most of these, particularly those in Madrid and Valencia, have long been under the control of PP regional administrations. Bankia's former chief executive, Roderigo de Rato, who was forced to quit last month, is a prominent PP supporter.

There have long been rumours that these regional administrations used their local savings banks to dole out loans to politically well-connected property developers.

These allegations, if true, could have a devastating impact on the PP, which returned to power last November after more than seven years in opposition, with its best-ever result since the return of democracy following the death of the long-serving military dictator General Francisco Franco in 1975.

What PP skeletons would be unearthed by a thorough investigation of the Bankia loan book? Mr Rajoy, perhaps not surprisingly, has so far resisted opposition calls for any kind of public inquiry into the running of Bankia.

Perhaps this is what explains the convoluted Bankia recapitalisation now being proposed by Mr Rajoy. He wants the EU's new bailout fund, the ESM, to pony up for any Spanish bank recapitalisation, rather than, as happened in Ireland, heap the entire burden on taxpayers' shoulders.

An ESM-funded Spanish bank bailout, which would set a useful precedent for this country as it seeks to reduce the burden of bank debt on Irish taxpayers, is being vehemently opposed by Germany. This is hardly a surprise, since it would end up footing most of the bill.

Germany would prefer if Mr Rajoy followed the example of Portugal, Greece and Ireland and "requested" an EU/IMF bailout.

No way, insists Mr Rajoy.

Meanwhile, nervous depositors are pulling their money out of Spanish banks, with €31bn being withdrawn in April alone. With the crisis having worsened steadily over the past month, it is virtually certain that the figure for May withdrawals will be much higher.

Even more disturbingly, much of this money is fleeing the country, with €97bn leaving Spain in the first quarter. This is capital flight on a major scale.

And Bankia is unlikely to be the only Spanish bank to require recapitalisation. If Bankia could go so bad so quickly, what other nasties are lurking undetected in the undergrowth of the Spanish banking system?

During the Noughties, the Spaniards enjoyed a property boom second only to Ireland's as euro membership slashed interest rates and allowed the Spanish banks to borrow virtually unlimited amounts from other eurozone banks, which they in turn lent to the booming property market.

With the boom now having turned to bust, the likely cost is beginning to emerge. The Brussels-based think-tank, the Centre for European Policy Studies, has estimated that the Spanish banks will have to write off up to €270bn of bad property loans.

If the full cost of repairing the resulting damage to their balance sheets was to fall on the Spanish state, its debts would quickly soar above 100pc of GDP and force the country into the arms of the EU/ECB/IMF troika -- a course that Mr Rajoy seems determined to avoid at virtually any cost.

Meanwhile, the EU Commission is pressing the Rajoy government to reduce the Spanish budget deficit from 8.9pc to 5.3pc of GDP this year.

However, with the Spanish unemployment rate at almost 25pc -- over 50pc for under-25s -- will such a sudden fiscal contraction make matters worse, rather than better?

Mr Rajoy appears to be trapped, no matter which direction he turns in.

And then there are Spain's sometimes tortuous politics. After the civil war of 1936-39, in which up to 500,000 died, Spain was ruled until 1975 by the right-wing dictator Franco.

While the post-Franco transition, which restored democracy to the country within three years of the dictator's death, was by any yardstick an outstanding political achievement, deep scars remain.

One of the legacies of the post-Franco transition has been the devolution of extensive powers, including fiscal powers, to Spain's 17 autonomous regions.

While this was a necessary price to pay, the full costs are only now becoming apparent. As a result of the devolution of fiscal power to the regions, the central government lost control over a large proportion of Spanish public spending.

Unfortunately, the Spanish regions seem to have made a complete hash of their fiscal powers. Most of them are effectively bust, with even Catalonia, by far the wealthiest Spanish region, admitting that it is no longer capable of paying its bills and seeking assistance from the central government.

Between them, the Spanish regions have debts of almost €36bn falling due for repayment this year, of which Catalonia owes more than €13bn.

In practice, the cost of repaying or rolling over these debts will fall on the central government. This combination of a huge central government deficit, massive unpaid bills coming in from the regions and the escalating costs of bailing out the banks has resulted in investors dumping Spanish government bonds, with yields on 10-year bonds hitting 6.8pc at one stage this week.

THAT'S bailout territory. If the markets cannot be persuaded to mark down the yield which they are demanding to purchase its bonds, then the Spanish government will have no choice but to seek a bailout.

For Mr Rajoy, the sometimes authoritarian leader of an often authoritarian party, that would be a humiliating climbdown -- one that he might struggle to survive politically.

For the opposition socialists, who were humiliatingly crushed in last November's general election, the Bankia affair offers the opportunity to put one over on the PP. Despite having been in government between 2004 and 2011, the socialists are largely in the clear when it comes to Bankia.

However, we in this country should be most concerned about the possible implications of the worsening situation in Spain for the future of the euro.

Any Spanish bailout, even if Mr Rajoy could be persuaded to ask for one, would be bigger than those of Greece, Portugal and Ireland combined.

Mr Rajoy's insistence on European recapitalisation of his country's banks is threatening the very existence of the euro. The price of his refusing to request a bailout could well be Spain's ejection from the euro or, at worst, the complete destruction of the currency.

Irish Independent

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