This week is of huge significance to Spain and it might be interesting to give a brief roadmap of how Spain got into its current predicament. Up until 2008, the Spanish economy had been doing well. For instance, real estate prices rose 200% from 1996 to 2007 and the Spanish banking system (with small local banks known as ‘cajas’) had been viewed as one of the best equipped to deal with a financial crisis. Prior to 2008, some regions of Spain were very close to having full employment.
So what went wrong? In the third quarter of 2008, Spain’s economy officially entered recession, after 15 consecutive years of growth. Not a big surprise really, seeing as most countries around the world also went into recession during this period. Rating agency Standard and Poor’s then downgraded Spain’s prized AAA to AA+ in 2009. So, they adopt an economic stimulus plan worth about 5% of their GDP, which leads to the exiting recession in the first quarter of 2010. Things look optimistic.
Then investors start to take a closer look at the Spanish economy and realize that the public deficit is huge: 11.2% of their GDP. After admitting Spain was in trouble, Prime Minister Zapatero introduced austerity measures to address the problem. He raised the retirement age from 65 to 67, reformed pensions and passed a constitutional amendment forcing governments to maintain a balanced budget. Zapatero was then voted out in late 2011, and Mario Rajoy’s conservative party filled the void with an absolute majority.
However, the Spanish economy was already on a downward slide, having produced no growth in Q3 and suffering a 0.3% contraction in Q4 2011. By March, unemployment had doubled the Eurozone average by climbing to 24.4% (it now soars above 25%). In April, thousands protested across the country against the government cuts, adding political instability into the mix.
In the summer of last year the Spanish banking sector began to crumble. Bankia requested a €19 billion state rescue in May, which pushed Spain itself into requesting €100 billion bailout for the struggling banks. In July, one of Spain’s richest regions, Catalonia, requested aid from the central government and several more followed suit as the gravity of the crisis surfaced. With borrowing costs setting fresh record-highs, it has come to a tipping point which appears to have prompted action from the ECB.
It goes without saying that the European Central Bank’s meeting in Frankfurt tomorrow could be crucial in the context of the Spanish and wider eurozone debt crisis. ECB President Mario Draghi has assured the market that the bank would buy enough bonds on the open market to put a stop to the “financial fragmentation” that currently exists throughout Europe. Draghi has hinted only this week that the ECB is free to buy government bond maturing in three years or less, without breaking the EU treaties and overstepping its mandate by stepping in to money-printing terrritory. This has already had a dampening effect on Spain’s soaring borrowing costs.
Whether the ECB unveils its plan to intervene in the bond markets on Thursday or not, it will do so fairly soon, that much has become pretty clear. But if a country wants to get their hands on this attractive offer from the ECB, they will first have to agree to a set of conditions. Just how strict these conditions are will determine how quickly Spanish PM Mariano Rajoy agrees to request help from the ECB. He asserted last week, "When I know exactly what is on offer I will take a decision.” Rajoy will not be able to get the ECB’s help for free but certainly Merkel needs to be careful in not overstepping the mark when making austerity demands of Spain’s already crippled economy. There is bound to be plenty of brinkmanship involved if Spain is to request help.
Whilst the ECB meets tomorrow, Rajoy and Merkel will be also be meeting, where it is anticipated that the two leaders will be negotiating an estimated €300bn Spanish sovereign bailout. September was always ear-marked as an all-action month and it looks as if we could indeed be on the brink of some major developments. Whether or not the market will be convinced remains to be seen.
Harry Drake
Caxton FX
