The Greek PSI will be resolved one way or the other this week. Early reports
suggest a weak start and the triggering of collective action clauses, and credit
default swaps remain a distinct possibility. Portugal is next and, although the
credit dynamics and implementation of reforms is superior to Greece, the risk
remains high that it will need a second aid package and/or debt restructuring,
as it is unlikely to be able to return to the capital markets in H2 2013. With 2
LTROs and collateral liberalization, the 10-year benchmark in Portugal is
yielding more than 13 percent, compared with a bit more than 12 percent at the
end of last year.
However, the devolution in Spain is particularly troubling.
The new fiscal compact had just been signed last week, which includes somewhat
more rigorous fiscal rule and enforcement, when Spain's PM Rajoy revealed that
this year's deficit would come in around 5.8 percent of GDP rather the 4.4
percent target. This of course follows last year's 8.5 percent overshoot of the
6 percent target.
The problem that for Spain is that the 4.4 percent target was based
on forecasts for more than 2 percent growth this year. However, in late
February, the EU cuts its forecast to a 1 percent contraction. This still seems
optimistic. The IMF forecasts a 1.7 percent contraction, which the Spanish
government now accepts.
This will be the third year in 5 that the Spanish economy
contracts. Unemployment stands at an EU-high of 23.5 percent in
February. The strong export growth seen in recent years, the best growth in the
euro area, is stalling. Domestic demand has been hit by rising unemployment and
government austerity. At the end of last year, the Rajoy government adopted a 15
bln euro package of spending cuts and tax increases.
Moody's says that
another 25 bln euros in savings is needed for Spain to reach its budget target.
Fitch says this is unrealistic and that the overshoot should not necessarily
impact their credit worthiness.
Spain is already under the excessive deficit procedure (since April 2009), as
are 23 of the EU 27 members. Rajoy's revelations butt against the EU agreement
that urged members to adhere to their fiscal commitments. Moreover, Rajoy struck
a strident chord by saying he did not communicate this to the other heads of
state because he did not have to and that Spain was sovereign.
In mid-February, a Reuters report
noted that the EU believes that the Spanish government overstated the 2011
deficit to make this year's data looks better. A recent Der Spiegel
report quoted a senior source in Berlin saying: "Everybody knows that the
Spanish are lying about the [deficit] figures."
Spain puts the EU in a difficult position. Belgium and
Hungary have already been formally requested to address their budget shortfalls.
The Netherlands is also coming under pressure after admitting recently that it
is not on track to reach the 3 percent deficit/GDP target next year. The EU has
to enforce the new agreement or lose credibility. On the other hand, enforcing
it runs risks of deepening the economic downturn and fueling social and
political instability, through which the EU also would lose credibility.
Some of the machinations of Spain's government could be related the
upcoming regional election in the autonomous regions of Andalusia on March 25.
Rajoy's Popular Party could win for the first time in more than 30
years. If so, the PP would govern 12 of the 17 regions. This is
important because the deficit overshoot on the regional level accounted for an
estimated 2/3 of the overall miss.
While Greece and the LTRO dominate the headlines, investors are
already marking down Spain. Since advent of EMU, Spanish 10-year
(generic) yields have been below Italy's with the notable exception being May
2010-August 2011. However this changing and Spain is beginning to pay a premium
over Italy. In part this reflects the incredible recovery in Italy after Monti
became the technocrat prime minister. The Italian 10-year benchmark yield has
fallen more than 200 bp this year already, while Spain's 10-year benchmark has
seen a 6 bp decline.
Perhaps an even more compelling evidence of the changed attitude toward Spain
is the 5-year credit default swap is now above Italy's for the first time in six
months. At the end of last week, Italy's 5-year CDS price fell to its lowest
level since last August. The Spanish 5-year CDS price had fallen to 340 bp on
Feb 8 and now stands at almost 387, about a one month high.
A confrontation between
Spain and the EU is likely in the coming weeks. There is no good
outcome and that's what makes it a tragedy. In Greece's case, implementation
was/is a problem. Portugal is implementing reforms but still not be able to
return to the capital markets as envisioned. Spain is (understandably) reluctant
to implement additional austerity and wants to miss this year's deficit target
after blowing through last year's.
Can EU fine Spain? Really ?
