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Spain battles market pressure, bailout risk remains

Source: Reuters - Wed 1st Dec 2010

Euro zone policymakers are keeping their fingers crossed too, as a call for outside help from the region's fourth largest economy would come close to extinguishing the huge reserves of capital they and the International Monetary Fund have set aside to contain the fiscal crisis, leaving the single currency area facing a bleak future.

Like Portugal, Spain is struggling to prove it has more staying power than other vulnerable euro zone economies as investors sell off its debt on concerns over a high deficit, especially at local government level and over banks laden with soured construction loans.

The yield spread on Spanish sovereign bonds over German benchmark Bunds hit a euro lifetime high this week and kept rising, brushing off data that showed tax hikes and spending cuts have slashed the central government deficit by 50 percent so far this year.

But at 250 basis points the risk premium is still well below Ireland's, which has soared above 630, and just four out of 50 analysts polled by Reuters between Monday and Wednesday said they believed Spain would need a bailout.

"Obviously if things go out of control then it would be a different story, but fundamentally Spain looks much stronger than some of the other periphery countries and funding requirements for next year do not look high" said a market maker on Spanish debt at a bank in London.

Spain's budget forecasts a cut in net debt issuance in 2011 to 43.3 billion euros (36.6 billion pounds) from 76.2 billion this year.

The government faces some 65 billion euros of debt payments next year, including interest, with the first major maturity coming on April 30.


Bailing out Greece, Ireland or even Portugal is one thing: but Spain's economy and debt are bigger than all three combined, says Deutsche Bank.

"If problems spill over to Spain the fund that is in place would not be enough to cover its financing requirements and would put into question the existence of the euro zone" said Marco Valli, chief euro zone economist at Unicredit.

A rescue aimed at meeting Spain's financing needs for 2-1/2 years would cost 420 billion euros, estimates Capital Economics, noting the European Financial Stability Facility reserve set up after Greece was forced into seeking a rescue in May barely have that left over after helping Athens and Dublin.

Spain has not run into troubles selling debt, but mounting borrowing costs threaten an unsustainable spiral, and government officials have taken to the airwaves to insist that austerity measures are working.

But they are painfully aware that just a few months ago, Ireland's deep spending cuts were held up as a model for euro zone economies struggling with debt.

"The government has to change people's perception ... They have to move more quickly, such as on pension reform, and deepen the labour reform, and then they have to do a better job of informing people" said Jose Luis Martinez, economist at Citi.


Unlike Ireland and Portugal, Spain has its 2011 budget in the bag and its debt as a percentage of Gross Domestic Product is estimated at 60 percent this year, compared with Ireland's 100 percent and Greece's 145 percent.

The government has shown willingness to make cuts, slashing infrastructure projects and state worker wages.

"Spain is the only country that has managed (to cut the deficit). In Ireland the deficit is rising even without the bank aid. In Portugal it hasn't improved at all" Jose Carlos Diez, economist with Intermoney in Madrid.

Spain's banks are also stronger than Ireland's. The government provided 15 billion euros in credit lines to savings banks and forced them to merge, and only a handful of smaller savings banks failed Europe-wide crisis simulations or stress tests.

The financial system's reliance on European Central Bank funding has come down after jumping during the Greek crisis.


But concerns persist that a renewed liquidity crunch on the interbank market combined with bad debt from Spain's property boom and bust could sink a bank.

"The genuine source of Spain's vulnerability lies in the adjustment of the private sector which accumulated before the start of the recession a debt of 210 percent of GDP... The banking sector bears the brunt of the adjustment" Deutsche Bank economist Gilles Moec wrote in a report this week.

Moec and other experts warn Spain should not overreact to market pressure with more austerity, possibly sending its stagnant economy back into recession.

Low growth next year would make it hard for the government to cut the deficit to 6 percent of GDP, since that target is based on what many see as an overoptimistic official forecast of 1.3 percent economic expansion.

The government insists that Spain's deeply indebted autonomous regions - with a combined debt of 10 percent of GDP and in many cases linked to Madrid through volatile political alliances - are committed to doing their part in deficit reduction.

But there are still concerns that regional finances are not transparent enough and that the central government might have to bail out a region, further straining its finances.

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