PARIS — In the euro zone’s simmering debt crisis, the Battle of Spain will probably be decisive in 2011.
But the
European Union is preparing to fight it with one hand tied behind its back, because Germany is blocking any financial lifeline for a country until it is actually drowning. Astonishingly, China, which pledged last week to buy Spanish government bonds, is doing more to help Madrid than Berlin is.
Since Greece and Ireland received bailouts from the European Union and the
International Monetary Fund last year to cope with their swollen public debts and deficits, Portugal has been everyone’s next candidate for a rescue, despite the government’s efforts to put its public finances in order.
In a Reuters poll last week, 44 of 51 economists surveyed expected Lisbon to need a bailout. Only seven thought Spain would need outside help, even though most expected Madrid’s credit rating to suffer another downgrade soon.
Spain has the euro zone’s fourth-largest economy. If it had to be rescued, it would stretch to the limit the capacity of the euro zone’s financial safety net — the €440 billion, or $571 billion, European Financial Stability Facility.
“Spain has a serious, realistic chance of avoiding a program because of the government’s actions to reduce the fiscal deficit, reduce public borrowing needs, make structural economic reforms and repair the financial sector,” a senior E.U. official said.
After months in denial, the minority Socialist government of Prime Minister
José Luis Rodríguez Zapatero has acted to cut public spending, increase privatization and bring forward a long-delayed pension overhaul.
Nevertheless, bond market pressure is likely to be fierce, with investors fleeing the debt of peripheral euro-zone governments because of worries about their ability to repay as interest rates rise, and because of fears of write-downs for bondholders.
E.U. officials are searching for ways to reinforce the euro zone’s financial backstop by increasing its effective lending capacity and broadening its scope for action.
But Chancellor
Angela Merkel of Germany, facing hostile public opinion and fearing a constitutional court veto, has rejected any pre-emptive standby credit line for troubled euro-zone countries before they are pushed out of the capital markets. Berlin has so far also opposed any increase in the size of the rescue fund and any use of that money to buy sovereign bonds in the secondary market or to help recapitalize troubled banks.
German resistance will be put to the test when euro-zone finance ministers meet Monday to discuss a comprehensive response to the potentially systemic crisis. If they are unable to agree on any strengthening of the financial safety net, that could hasten a backlash in the markets.
“We are quite negative on Portugal,” said Pavan Wadhwa, a European rates strategist at
J.P. Morgan, adding that Portugal was expected to be the next to tap the bailout fund. “We’re not so sure about Spain. It’s a question of a toss of the coin.”
Madrid’s fiscal challenge was easier than those of Greece, Portugal and Ireland, Mr. Wadhwa said during a conference call, and the Spanish government is making progress in cutting the budget deficit and using privatization revenue to reduce borrowing needs.
But the market was still pricing in a 15 percent to 20 percent marginal possibility of a Spanish default in each of the next five years.
Spain’s troubles, like Ireland’s, result mostly from the bursting of a real estate bubble that was inflated by low interest rates. Unemployment stands at 20 percent, and the economy is barely growing.
Although Spanish public debt is still well below the euro-zone average and the two biggest commercial banks, Banco Santander and Banco Bilbao Vizcaya Argentaria, which is known as B.B.V.A., are in good shape, the state faces contingent liabilities from a damaged financial sector.
Madrid’s fiscal problems are compounded by the need to recapitalize its unlisted regional savings banks, the cajas, whose numbers were cut by mergers from 45 to 17 in an overhaul last month and which have an unrecognized exposure to bad real estate loans.
“The losses related to the commercial real estate sector are potentially two to three times as big as those linked to the residential sector,” said Laurence Boone, research director at
Barclays Capital in Paris.
She considers Spain’s debt situation manageable, provided 10-year bond rates remain below 7 percent. The yield on Spanish bonds with that maturity was about 5.5 percent at the end of last week, but Portugal’s borrowing cost was 6.95 percent and rising.
Spanish banks also have a large exposure to Portuguese public debt, and would suffer if they could not use Portuguese bonds as collateral in central bank liquidity operations.
Both Spain and Portugal face big financing crunches in April and midyear. Portugal must repay more than €12 billion in the first half of 2011. Spain faces bond redemptions of €15 billion in April and another €15 billion in July.
So the euro zone may not have long to build a more effective firewall before the flames start licking around the Iberian Peninsula.
Paul Taylor is a Reuters correspondent.
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