SPAIN - BACK BEING A 'PAIN'

By Ruma Dubey

Europe is back on the ‘worry map’ and once again, the epicenter of this stress is Spain. Like a bad penny which keeps turning up again and again, the crisis in Spain is back on the fore. We just assumed it was gone; like brushing it under the cupboard from eye view but it was always there, underneath, and as the mess got bigger, it’s now poking its head out.

Last week, the Spain’s bond auction was a huge flop show, it managed to sell bonds totaling just 2.589 billion Euro’s, which was near the lower-end of its targeted range. The cost of insuring Spanish sovereign debt against default rose to its highest level in more than four months, while benchmark 10-year Spanish debt yields hit their highest levels in 2012 at 5.75%.  This means that today it is almost next to impossible for Spain to borrow in the international markets; it simply cannot afford it.

The poor sale of bonds has once again raised worries about the crisis in Spain. The country was supposed to have reduced its budget deficit to 6% of its GDP from 9.3% in 2011 but it managed to bring it down to just 8.5%. Poor economic growth and inability to bring in stricter austerity measures were named as the culprits. This year, Spain has promised to usher in even more stricter austerity measures and bring down the budget deficit to 5.3% of the GDP by Dec 2012.

But how will Spain get to 5.3% when it is staring hard at a huge unemployment figure of a staggering 23%.More worrying is the fact that youth unemployment now exceeds 50% in both Spain and Greece as the number of people out of work in the eurozone as a whole, hit a 15-year high of 17.2 million.  And adding to this woe is crisis brewing in the housing market, where prices are expected to crash to record lows this year as every one person in four homeowners in Spain today owes more than the worth of their property.

So when the country is as such grappling with a huge unemployment, poor economic growth rate and slowing realty markets, how can stricter austerity measures be ushered in? Austerity would essentially mean more people will be asked to go but when unemployment is already so high, can Spain afford to add on more? More austerity is sure to lead to social unrest in the country and to top it off; it might not meet the objective of bringing down the budget deficit.

Spain had already passed an austerity budget in 2011 which included tax rises for the rich, a 28% increase in the tax on tobacco and 8% spending cuts. On 31st March it announced another cut of 27bn euros ($36bn; £22.5bn) from its budget and froze public sector salaries to try to address its "extreme" economic situation.

Thus for the global markets now, it is not Spain’s debt but the austerity measures which are spooking the markets. It now seems there is more austerity than growth in the region. The worry is that despite these tough austerity measures, given the economic crisis in the country, it might eventually need another bailout. Just as Greek bondholders had to take a haircut, there is worry that the same fate awaits those invested in Spanish debt. Collapsing economic growth and unreconstructed banking system is like a time bomb waiting to explode.

The overall outlook for the Eurozone remains dismal in 2012. The European Commission's forecast is for a eurozone contraction of 0.3% in 2012 and that for the ‘bailed out’ countries is worse – Greece is expected to contract by 4.4% and Portugal by 3.3%. There are auctions scheduled this week – from Germany and Italy and with Germany currently looking as the safest haven, naturally, the gap of yield between Italy and Germany is expected to be starkly wide. Plus, this is election year in France and Germany.

This means the world will look at USA for signs of good news but it too disappointed on Friday as it added jobs at far slower pace than expected in March, indicating that the US economy remains sluggish and this in turn reiterates the US Fed’s move to keep rates intact till 2013.

Thus for now, India has a lot happening locally - IIP data, Q4 numbers, Credit Policy; and may not pay too much attention to these dark clouds once again looming over Europe. But nevertheless, the clouds are there and unless the RBI makes the ‘market friendly’ move of reducing rates, eyes could get automatically drawn to these dark clouds.