Key risks to watch out for in Spain

 

Some economists worry Spain's poor economic prospects could eventually lead it to suffer Greek-style financing problems, only on a much larger scale given that the Spanish economy is the eurozone's fourth-largest.

After a decade of inflation running at higher than the euro-zone average, Spain has been left relatively uncompetitive and saddled with very high levels of household and corporate debt. Unless the country can reform its labour market and cut the cost of doing business here, economists fear the government will not be able to get its fiscal deficit under control.

Following are some of the key factors to watch:

MORE BANKS FAIL

So far, only one small regional savings bank has failed during Spain's crisis but there are fears more of the savings banks, which are largely unlisted and have close links to regional governments and invested heavily in the property boom and in property developers, could go under if a much-mooted restructuring of the banking system here does not begin to happen soon. While Spain's big listed banks, such as Santander and BBVA, have withstood the financial crisis better than many of their peers abroad, authorities say that some smaller institutions are too weak to stand alone. The government has provided a 9 billion euro fund, extendible to up to 90 billion euros, to enable healthy banks to take over struggling banks, but bankers complain that the conditions it has imposed make takeovers an unattractive proposition. Meanwhile, the clock is ticking on a June deadline, after which the government will need permission from Brussels to continue to make the restructuring fund available. The main cause of the problem is the roughly 325 billion euros banks have lent to developers - about a third of Spanish GDP. Many of these developers are in serious trouble and non-performing loans are creeping up. Even BBVA and Santander, which have diversified heavily outside Spain, have had to raise provisions due to rising bad debts, and some analysts fear the situation could get worse.

Any bank failure would probably hit Spanish Treasury bonds, as it would raise suspicions that the government will have to pump in more money to revive the financial sector, and also the share prices of the big listed banks, although no one thinks their future is in doubt. Share prices for the big banks, such as Santander, took a dive in February along with other risk assets, but are roughly double pre-crisis lows.

WHAT TO WATCH

- Progress on the bank restructuring talks, which have yielded nothing so far.

- Any more big defaults by property developers

- Banks' non-performing loans ratio.

DEFICIT CUTS FALL SHORT

Investors will be keeping a close eye on the government's progress in trying to meet its promise to slash the public deficit from 11.4 % of gross domestic product in 2009 to the EU guideline of 3 % by 2013.

Central to achieving that will be a 50 billion euro austerity plan which will include a hiring freeze for the public sector of 4 %.

But analysts say the reform, and a planned rise in value-added tax of 2 % points from July, do not go far enough.

They also doubt the plan's assumptions that the Spanish economy will return to annual growth rates of 3 % by 2012. If growth remains weak, then tax revenues will be lower than expected and social spending possibly greater, making the fiscal targets harder to reach.

However, Spain faces less immediate pressure than Greece over its financing needs as its public debt to GDP ratio is one of the lowest among OECD countries at 55.2 % in 2009. Greece's debt is set to hit 125% of GDP this year.

WHAT TO WATCH:

- More details of where austerity measures will come from. Will unions and public opinion oppose cuts? Spain's autonomous regions, which account for around half of the country's spending budget, will also be key if measures are to have any success.

- Any renewal of fears of Greece's debt problems spreading to other euro zone countries and making it harder for Spain to meet its financing needs. The last outbreak of market nerves over Greece in February caused a spike in Spain's financing costs, although to a much lower level than Greece as Spain's problems seem to be further out in the future. The spread of Spain's 10-year Treasury bonds over Germany's bunds shot up to 100 basis points. It eased back to about 70 in March, compared to a 290-basis point spread for Greek bonds.

This would likely push up Spanish bond yields and the cost of insuring its debt in the credit default swaps market -- both of which have been effectively fluctuating in sympathy with Greek asset moves although are priced as much less risky. The cost of insuring Spanish debt is considerably lower at 89,000 euros a year to protect 10 million five-year debt compared to 273,000 euros for Greece.

- How will debt auctions be received this year? - So far Spain has not had difficulties, but it needs to issue 76.8 million euros worth of debt over the course of the year.

- Any move by ratings agencies to lower their outlooks on Spain. Standard & Poor's lowered its outlook on Spain to negative in December and warned the country would have to take serious steps to rein in its public deficit to avoid a downgrade in 2 years.

- Will growth undershoot the government's forecasts? - This year it expects the economy to contract by 0.3 %, after shrinking 3.6 % in 2009.

UNIONS BLOCK LABOUR REFORMS

The government aims to present a labour reform package negotiated with unions and business groups by April.

With euro membership ruling out devaluation, cutting the cost of employing workers in Spain will be key if the country is to cut costs by the 15 % or so economists say it needs.

But so far, the talks do not seem to be making much progress, with unions angrily dismissing an idea floated by business leaders for no compensation for young workers who lose their jobs. Severance packages are currently among the highest in Europe.

Both the government and unions want to see an end to the over-use by companies of temporary contracts which made it easier for firms to fire people during the crisis. Around 90 % of people who lost their job were on temporary contracts.

Talks have been made more difficult by the government's decision to increase the retirement age to 67 from 65, which has angered the unions.

WHAT TO WATCH:

- Market disappointment should talks fail. This could conceivably be a bearish factor, in the medium-to-long term, for Spanish bonds.

- Union protests. Unions have hinted at a general strike if workers' benefits are cut or the pensionable age raised. But this looks less of a threatening prospect now, following the relatively low turnout for protests called at the end of February by the two main labour confederations against the government's pension proposal.

UNEMPLOYMENT KEEPS RISING

The number of unemployed rose to 4.13 million people in February. The government forecasts 19 % of the working population to be out of work this year, while some economists say it will top 20 percent. Youth unemployment in Spain stood at 39.6 % in January, according to the European Commission.

WHAT TO WATCH:

- Any significant rise in unemployment above 20 % will force the government to spend more on unemployment benefits, reduce consumer spending, and make it harder for the government to push through further austerity measures. This could hit bond prices and push up credit default swaps.

LOSS OF CONFIDENCE IN GOVERNMENT