The Spanish government has recently announced a tough package of fiscal austerity measures in its budget for 2012. But implementing these reforms will prove very difficult in what remains of the year. And with the economy already in recession, it would be very surprising if this package is sufficient to lower the deficit to the 5.3% of GDP target. On EU measures, government debt in Spain amounts to 70% of GDP, a lower level than both Germany and France. This seems to imply that Spain has plenty of room for manoeuvre. But the data flatter the government’s true financial situation – a consolidated measure of the general government finances indicates that the true level of debt is actually around 82% of GDP.
Even more worrying are the state’s ‘contingent liabilities’ in the banking sector. The banking system remains heavily exposed to the property market and the process of cleaning up the balance sheets of Spanish banks may have only just begun. Further house price declines are likely to increase loan losses on property, while asset quality across the broader loan book of the banks is likely to deteriorate as the economy contracts. The government may eventually be forced to step in with a much larger bailout of the financial sector to prevent the failure of institutions deemed too important to fail. Spain appears to be locked in a worsening debt trap, with high levels of debt in both the public and private sectors. Given the dire economic and financial situation, there is a high risk that it will eventually need to seek assistance from the Troika (EU/IMF) programmes.
Spain appears to be locked in a worsening debt trap, with high levels of debt in both the public and private sectors. The deleveraging process has only just begun and financial markets are beginning to awaken to the fact that the outlook for Spain appears bleak as long as fiscal retrenchment efforts take place alongside balance sheet consolidation in the private sector. This change inperceptions is demonstrated by the increase in Spanish yields above those of Italy for the first time since August, an indicator of how investors view the relative creditworthiness of the two countries.
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