Europe’s Future Lies, Ominously, with Spain
The European Union is facing an existential crisis, and all eyes are now on Spain to see what happens next.
November 29, 2010 - 12:00 am
A massive €750 billion ($1 trillion) bailout fund announced by European officials just six months ago has failed to contain the sovereign debt crisis that now threatens to bring down the euro single currency. After having spent €110 billion to rescue Greece from bankruptcy in May, Europe and the International Monetary Fund on November 28 announced a rescue package worth €85 billion to prevent a financial meltdown in Ireland. Europe’s debt contagion now threatens to take down Portugal and possibly even Spain.
A debt crisis in Spain would make the problems in Greece, Ireland, and Portugal look pale by comparison; at €1.3 trillion, the Spanish economy is bigger than those three countries combined. Spain is the fifth-largest economy in the 16-nation euro zone, the ninth-largest in the OECD, and the eleventh-largest in the world.
Analysts say the price tag for a Spanish bailout could exceed €500 billion, leading many observers to conclude that Spain is too big to be rescued, and that a Spanish default would almost certainly lead to the breakup of the euro zone.
Spanish politicians insist that Spain is not dancing on the edge of the abyss. Spanish Prime Minister José Luis Rodríguez Zapatero, for example, has dismissed speculation that the country would need a bailout as “complete madness.” Spanish Finance Minister Elena Salgado says Spain will “absolutely not” need help from the European Union, and that the country is in “the best conditions” to resist “speculative attacks.”
But investors — spooked by the size of the bailouts for Greece and Ireland — are not convinced, and the extra yield they are demanding to hold Spanish 10-year debt rather than rock-solid German bunds, Europe’s benchmark securities, has surged to its highest level since the single currency was introduced in 1999. That spread, or difference, represents the extra interest cushion investors are demanding to hold Spanish debt, which is now perceived to be more risky than ever.
With its borrowing costs rising, the Spanish government on November 24 was forced to freeze a plan to sell €13.5 billion worth of state-guaranteed power-revenue bonds until the volatility in sovereign debt markets abates. Spain was also forced to nearly double the interest paid on short-term bonds in an auction on November 23.
Spain’s problems largely stem from the collapse of the country’s housing and construction sectors, which accounted (directly and indirectly) for nearly one quarter of Spanish GDP before a speculative real estate bubble began to burst in 2007. The ensuing spike in unemployment, coupled with a sharp drop in domestic consumption and a steep decline in tax revenues, among myriad other woes, have all combined to leave Spain mired in its worst recession in 60 years.
The Bank of Spain projects that GDP growth will be zero in 2010, after falling nearly 4 percent in 2009. Spain’s jobless rate is stuck at 20 percent, almost twice the EU average. At the same time, Spain’s benchmark IBEX stock index is the euro zone’s worst performer this year after Greece.
Spain’s debt to GDP ratio is expected to climb from 53.2 percent last year to 64.9 percent this year and 72.5 percent next year. But investors are particularly concerned about Spain’s gaping budget deficit, which at 11.3 percent of GDP is the third-largest in the euro zone, and which may exceed that of Greece this year, according to the European Commission.
In late May, the Spanish Parliament narrowly approved a €15 billion austerity plan to rein in the public deficit and ease fears of a Greek-style debt crisis. The measure, which is intended to reduce the deficit to 6 percent by 2011, includes cutting the pay of public sector employees by 5 percent and freezing that pay next year. The plan also calls for suspending automatic inflation-adjusted pensions and scrapping a payout parents get for the birth of new children.
Although these measures won Zapatero some respite from the markets, they also left his political future hanging in the balance. In the face of public strikes organized by Spain’s largest labor unions, as well as a more than 10-point decline in support for his Socialist Party, Zapatero put off other reforms. Now, with the crises in Ireland and Portugal, nervous investors are once again focusing on Spain’s public finances.