Spain’s economic problems deepen and as its problems deepen so does its ability to support and repay its debts weaken. I am in particular disturbed by many a loose sanguine comment over the risks of a Spanish default without, apparently, taking the time to explain in context some of the unique characteristics of the Spanish debt problem.
Since the 4th quarter of 2007, Spanish government expenditure has grown 6%, household domestic consumption expenditure has fallen close to 7% and gross fixed capital formation has fallen by close to 36% (residential construction –45% and machinery and capital goods –30%). In addition to a positive contribution from government expenditure, exports have grown close to 10% and imports have fallen close to 21%. Export growth is slowing and with government expenditure set to act as a drag on growth, economic conditions could well worsen. This data on the Spanish economy has been sourced from Spain’s INE
No doubt, much of the present downturn in economic activity and employment may well be an overreaction to present and past conditions, and would usually prove to be excessively negative data points. The problem is the expanding weakness in the rest of Europe, its own high unemployment and falling tax base. Most sharp rebounds are aiding by counter cyclical economic policies and monetary stimulus: instead we have a proposed austerity program and no sovereign central bank independence.
Government debt continues to accumulate as the bad debts of the banking sector continue to amalgamate with those of general government. Importantly, home ownership in Spain is particularly high (some 82% according to a recent IMF report) with a significant portion of wealth held in form of housing (according to the same IMF report), meaning that the weakness in the housing sector coupled with very high unemployment rates (25%) could continue to impact growth for some time. Housing sector related debt not only impacts the household sector, but also a great many non financial corporations who are particularly exposed to housing related debt. Note the following excerpt from the same noted IMF report:
Overall, despite areas of strength and factors mitigating economic stress,
household indebtedness remains a concern. Mitigating factors (lower interest rates in particular) had an important role in the downturn. But since 2008, the debt servicing ability among households has weakened. Given the bleak economic outlook, the debt servicing ability is expected to deteriorate further. The sensitivity analysis carried out for the Spanish
households show that households are most vulnerable to rising interest rate and weaker economic activity. The impact of the ongoing recession is expected to be most severe for borrowers among the poor and the young, which have already been hit hard.
The Spanish corporate sector remains vulnerable and credit risk in the Spanish corporate sector is expected to increase further. The current recession would aggravate firms’ financial positions and debt servicing ability. The sensitivity analysis shows that a number of vulnerable firms and the debt at risk increase significantly with macroeconomic shocks. More defaults would be expected among most vulnerable sectors, including construction and real estate. Firms are adjusting and restoring their balance sheets. The deleveraging process will continue, but take long time to complete. Financial stress and corporate vulnerability would remain elevated for some time.
Many economists and asset managers have been fairly sanguine to date over the prospect of a Spanish default, but far from the risks getting smaller, they have continued to escalate and appear to have substance in reserve. The unwinding of the housing and construction bubble in Spain has yet, it would appear, to have fully evolved.
High debt commitments and fiscal austerity imply a huge burden for the Spanish economy, perhaps too high a burden. Debt will most likely need restructuring at some point in time, irrespective of promises of ECB support. Housing/construction debt/supply dynamics would appear to be critical (much more important to a recovery than in the US), and again I reference the same IMF report, house price to income ratios remain very high in Spain.
Other useful references