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Rajoy May Need Back Door Bailout for Regional Rescues

Source: Bloomberg - Thu 12th Jan 2012
Rajoy May Need Back Door Bailout for Regional Rescues

Rajoy may need to skirt Spanish law to backstop the nation's indebted regions, mimicking the EU's dodging of its no bailout rule to save Greece, Ireland and Portugal from default.

"We consider the Spanish government should guarantee or take responsibility for the debt it has authorized the regions to issue," said Albert Carreras de Odriozola, Catalonia's deputy finance chief, in a telephone interview. "It must be possible to talk and find a mechanism."

Catalonia, Valencia, Andalusia and Madrid, which account for 60% of Spain's economy, are shut out of markets as they brace to repay 9 billion euros to lenders this year, according to data compiled by Bloomberg. Spain's 10- year yield has risen to 5.3% from 5.09% on Dec. 30 when the government said its 2011 deficit had ballooned to a third larger than its target.

Regional shortfalls drove Spain's deficit to 8% of GDP, breaching the 6% pledged to the EU. Spain's Parliament today examines 15 billion euros of tax increases and spending cuts announced by Rajoy's government on Dec. 30 to compensate the slippage.

Failure not Option

"Rajoy cannot afford for regional governments to fail," said Michael Derks, chief strategist at FXPro Financial Services Ltd. in London. "What Rajoy may well need to do is to provide a limited guarantee on regional funding, on the proviso that those regions who take advantage of the guarantee sign up to fiscal reforms."

The yield on 2020 bonds of Catalonia, the wealthiest region with an economy the size of Portugal's, reached 9.738% today compared with 5.029% for similar maturity Spanish government debt.

Budget Minister Cristobal Montoro meets today at 7 p.m. in Madrid with the economy chiefs of the 11 regions governed by Rajoy's People's Party, as falling tax receipts in a country with an unemployment rate of 23% aggravate efforts to repay debt. A summit with all 17 regions is scheduled for later this month. Spain's regions have more than 135 billion euros in borrowing, compared with 518 billion euros for the central government.

Valencia, with the highest debt-to-GDP ratio among the regions, saw its credit rating cut to non-investment grade by Moody's Investors Services last month, and was forced to delay repayment of a 123 million euro loan to Deutsche Bank AG for a week.

Seeking Concessions

Catalonia has asked for a delay in handing tax payments to the central government. It also suggested Madrid guarantee regions' debt sales to attract lenders.

Weeks before he was called to join Rajoy's government in December, Economy Minister Luis de Guindos said that a "fiscal and liquidity pact" with Spain's provinces was needed.

The regions' sagging finances threaten Spain's credit rating, which could further boost borrowing costs. Moody's, Fitch Ratings and Standard & Poor's all cited the regions in putting Spain's ratings under review last month, signaling they were an obstacle to Spain's efforts to reorder its finances and avoid becoming the fourth euro nation to seek aid.

The Treasury tomorrow sells as much as 5 billion euros of bonds, including a new three-year benchmark. Spain was forced to offer 5.187% to borrow till April 2015 on Dec. 1, compared with the 3.9% that Germany last paid to sell similar maturity debt.

Rescues Barred

Spanish law forbids the government from rescuing local governments in much the same way that the Maastricht Treaty prohibits bailouts of EU countries. Still, the EU managed to bend that ban in coming up with 256 billion euros in aid packages to avert the first euro area default.

The central government could try to convince banks to grant the regions loans, eventually offering an "informal" guarantee, said Angel de la Fuente, an economist at the National Research Council's Institute of Economic Analysis who specializes in regional finances.

"Informally, they can get banks to be a little bit softer," he said.

Rajoy may be better positioned than his Socialist predecessor Jose Luis Rodriguez Zapatero to wrest concessions from the region's as his People Party now controls 11 of the 17 regions. Shoring up the regions will be the only way for Rajoy to deliver on his pledge of cutting the budget gap by almost half to 4.4% of GDP this year.

Meeting that call will require an "unprecedented adjustment," Moody's said on Jan. 9, calculating that about 40 billion euros in deficit reductions would be needed, an amount equivalent to 3.7% of GDP. Newspaper Expansion reported today that the Rajoy's government is considering cuts of about that amount.

"The new government is in a very difficult situation," said Raj Badiani, an economist at Global Insight Inc. in London. "Given that several regions have missed their 2011 budget targets, they may not be allowed by the central government to issue new debt, adding to their liquidity and even solvency pressures."

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